3 Serious Risks of Not Having a Sufficient Emergency Fund

It’s widely agreed among experts that one of the first big financial steps you should take is building an emergency fund. Before focusing on investing or paying off debt, save at least $500 to $1,000 for emergencies. Over time, aim to build an emergency fund with three to six months’ worth of living expenses.

Not everyone does this. For example, the average savings account balance is only $1,200. For most people, this amounts to three to six months of living expenses. Let’s be honest, building an emergency fund is hard work and not the most exciting part of personal finance. It’s understandable why you might be more interested in saving for a home or investing to make money.

That doesn’t mean it’s a good idea. This is because not having a sufficient emergency fund can expose you to serious financial problems.

1. Going into debt to cover emergency expenses

Imagine the worst-case scenario: you lose your job or have an unexpected $5,000 bill. If you have a large emergency fund, you can withdraw it to cover expenses. Still not fun, but at least I was prepared.

What do you do if you don’t have enough money saved? You have to pay your bills, and that means borrowing money from somewhere. This can mean one of the following:

• Increase your balance with a credit card with an average interest rate of 21.47%.
• Get a personal loan — The average interest rate for a 24-month personal loan is 12.35%.

This is a high interest rate, so it can cost you a significant amount of money in interest.

If you’re stuck, there are 0% or better introductory APR credit cards. Some of them have an introductory period of 15 months or more during which no interest is charged. However, you generally need a high credit score to qualify. You’ll also still owe money, and even after the introductory period ends, the 0% APR will skyrocket to the card’s regular interest rate.

2. If payment cannot be made from your account

Borrowing money can help you get through an emergency, but it’s not a long-term solution. In fact, it can make it more difficult to recover financially because you’ll be adding debt payments to your monthly bills. You must repay money you borrow through a loan or credit card.

Let’s say you’re living paycheck to paycheck. I take it home and spend $4,000 a month. Unfortunately, you end up paying $5,000 in car repairs or hospital bills. To repay that money, I take out a 24-month personal loan with an interest rate of 13%. You’ve taken care of the immediate problem, but now you have a monthly loan payment of $238.

Hopefully, you can make it work and get all your bills paid. However, situations may arise where you eventually become unable to make the required monthly payments. If you have a credit card or loan, you’re likely to be charged late fees, putting you deeper into debt. There’s another way it can take a serious toll on your finances.

3. Damaged credit rating

If you are unable to make a payment on your account, this will be reported to your credit report. It will not be processed immediately. Your account must be at least 30 days past due. Being more than 30 days late can seriously damage your credit score.

The exact amount will depend on your credit history prior to delinquency. For consumers with excellent credit, one late payment can lower their credit score by up to 110 points. The situation gets even worse when your account becomes 60 and 90 days delinquent and the creditor eventually decides to write off the account and send it to collections.

If this happens, it can take a long time to rebuild your credit. Arrears and charge-offs are kept on your credit file for seven years. It doesn’t take that long to get back into good credit, but it’s a process that can last for years.

A strong emergency fund is essential

An emergency fund is an important part of maintaining financial security. If you don’t have one yet, or don’t have enough to cover at least three months’ worth of living expenses, make it a priority for 2024.

Find out how much you can save in your emergency fund each month. Then set up an automatic transfer for that amount to your savings. Use a high-yield savings account as an emergency fund and receive competitive interest rates.

Building an emergency fund takes time, but you’ll be glad you did. This gives you peace of mind that you are ready for anything.

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