According to a survey conducted by GOBankingRates, 62% of Americans have less than $1,000 in savings. This means if a financial emergency occurred, more than half of Americans couldn’t handle it simply with cash. They’d have to rely on credit, borrowing money from friends/family, or even dipping into their retirement accounts to cover a financial emergency.
These statistics are alarming. Having an emergency fund is the starting point to financial freedom and sound money management. It protects you financially in the event of a job loss, a large medical bill, unexpected car repairs, and other unplanned expenses.
Building an emergency fund is just the start. For those who are fortunate enough to have tucked away a decent amount of money for a rainy day, it’s important to use it for the right reasons. If you use your emergency fund for non-emergencies, you are defeating the purpose of having it in the first place. Here, we’ve laid out five ways people misuse their emergency and how to avoid them.
Things You Should Never Use Your Emergency Fund For
To Pay For A Vacation
We all like to take vacations every now and then. But this type of expense should be paid for more intentionally; a vacation is not a need, it’s a want. So the cost should come out of your discretionary income.
If you are absolutely certain you want to take a vacation at a specific time of year, you can even set up a separate savings account just for that goal. Simply sign up with a bank that offers multiple sub-accounts as a feature. Capital One 360 is great for that.
If you’re having trouble saving money into an emergency fund, you may want to consider cutting vacation spending from your budget. There are plenty of ways to give yourself a relaxing weekend (or longer) without spending tons of money on flights and hotels. You could have a staycation and visit places in the city you currently live in. You could also visit nearby family or friends who would let you stay with them for free.
To Buy Gifts
According to a survey conducted by the National Retail Federation, the average person spends over $800 on gifts during the holiday season. It’s no surprise how this amount might cause people to use their financial safety net! However, emergency funds aren’t meant for gifts, which are obviously, well, not emergencies.
With gifts, you need to plan ahead. If you know you would like to buy gifts for a certain number of people this holiday season, simply set a budget for each gift. Then, you could start another savings sub-account for that specific goal. Divide the goal by how many months there are until you plan to shop. That’s how much money you should be putting into the savings account each month.
To Put A Down Payment On A Home
While a home can be a great investment, you shouldn’t use your emergency fund money to make a down payment. Depleting your emergency fund to put a down payment on a home can actually lead you into more financial trouble. There are plenty of hidden costs that come with owning a home — namely maintenance. Your emergency fund is better used for those expenses after you own the home.
As with saving for a vacation or gifts, setting up a separate savings account for your down payment goal is the best way to go. It may take you longer to buy your dream home, but you’ll be more financially prepared this way.
To Lend Money To Someone
Your emergency fund is there to cover any personal emergencies you may have. It’s not a reserve for others to tap into when they’re low on cash or otherwise in need of some money.
Before you use your emergency fund to help a friend or family member, consider the impact it’ll have on your finances. If you had an emergency tomorrow, would you still be able to cover it after handing over that money?
A good rule of thumb is to only lend money you can afford to lose. Your emergency fund is not money you can afford to lose. If you have discretionary income that you don’t mind giving away, use that to lend instead. If not, you may want to point your friend or family member in the direction of other resources, such as peer-to-peer loans or lines of credit from a bank.
Resource: 5 of the Best Personal Loan Rates
To Cover Annual Expenses
Annual expenses that you don’t plan for can seem like emergencies when they come around, but let’s be honest: they really aren’t. Just because the expense occurs once per year doesn’t mean you can’t plan for it. Examples of annual expenses include renter’s insurance, property taxes, warehouse club membership fees, tax preparation fees, and much more.
There are a couple of ways to plan for annual expenses. The first is to save for it throughout the year. Simply divide the expense by 12 and save that amount of money each month into a dedicated savings account. When the annual bill comes, you’ll be prepared to pay it easily!
The other way to plan for annual expenses is to put the amount of the bill aside after it’s paid. In other words, after you pay the bill, put aside the same amount of money in an account so that you’ll be ready to pay the bill next year.
Questions To Ask Before Using Your Emergency Fund
Now that you know a few occasions when you shouldn’t use your emergency fund, here are three questions you can ask yourself before dipping into the account. These will help you decide if the expense is truly an emergency and if you should indeed use your funds.
- Is this expense unexpected?
Some things in life can’t be predicted — like your washing machine goes out or a pipe bursts. These are the kind of things that merit using your emergency fund.
Ask yourself the question: “Is this expense unexpected?” Then, be truthful with yourself on the answer. Only use your emergency fund for things you cannot plan for.
- Is this expense urgent?
Some things may be unexpected but not necessarily urgent. Let’s say you’re sitting in your dentist’s office and find out you need a procedure that will cost a large amount. Your first instinct may be to use your emergency fund.
But before you do that, find out the details of the expense. Will you have to pay the day of the procedure, or will you receive a bill in the mail? If you receive a bill in the mail, you may have enough time between when you receive the bill and its due date to come up with the money some other way.
Urgency is definitely something you should consider before using your emergency fund. If you have enough time to put some money together without using your safety net, you should look into that option.
- Is this expense absolutely necessary?
Here you’ll want to go back to the fundamental difference between needs and wants. If the expense is unexpected, urgent, and necessary, you’ll definitely want to use your emergency fund. On the other hand, if the expense is for something you don’t necessarily need, you’ll want to reconsider dipping into that money.
For example, if your car breaks down and that’s your only transportation to work, you’ll need to use your emergency fund to fix it ASAP. If your car breaks down and you could easily use public transportation in the meantime, you can wait until you save up some more money to pay for the maintenance and avoid using the saved cash.
As you can tell, there’s a lot that goes into determining when you should use your emergency fund. There are some instances when you definitely shouldn’t touch it — most of which are for non-emergencies.
You can use the questions above to help you decide when to use your emergency fund. There are a few common expenses that meet the criteria (unexpected, urgent, and absolutely necessary). Three of them are: a large medical bill, a car repair, and bereavement-related expenses.
Having an emergency fund is very important. If you have one, you’re on the right financial track. If you don’t, you’re unfortunately not alone.
The best way to start building an emergency fund is to identify savings opportunities in your monthly budget. Take advantage of those opportunities and set aside the money saved into a dedicated savings account. You’ll want the money to be accessible enough so that you can get your hands on it in the event of an actual emergency.