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Should You Build An Emergency Fund When In Debt?

Despite  debates to the contrary, I am a big believer in setting aside some funds (at least 3 months living expenses) for emergency use. For employed folk, you may be out of work and this fund cushions you as you look for alternative sources of income.
For people in business, an emergency fund is even more critical because business income is unpredictable. Most opponents of emergency funds say that one can always get a low interest credit card for emergencies. This may not work in Africa, where credit cards are for those with an income and come at crazy interest rates.

For people without debts, then saving obvious. The question then is, should you build an emergency fund when in debt?
I think you should for two reasons:

1. Having an emergency fund gives you peace of mind. When repaying debt, you end up feeling like you’re pouring your cash into a bottomless hole, and without seeing any returns. Building an emergency fund as you repay your loans gives you a sense of accomplishment, and peace of mind that should something disrupt your income, you won’t be out cold.

2. Should an unexpected financial need arise, you won’t get into additional debt if you have an emergency fund. It is key not to accumulate additional debt when trying to get out of debt.

How do you go about building an emergency fund when in debt?

First, establish how much you need to set aside and within what time. If you are setting aside 3 months worth of living expenses, ensure that you not only include the regular expenses (rent, food etc), but the irregular ones like insurance, motor vehicle repairs, medical expenses etc in your estimates.

Set aside whatever little you can every month and keep increasing it as your debt repayments decrease. The key thing is to stick to the plan until you reach your goal. Do not wait until you have enough money to save, you never will. When building an emergency fund, do not stop repaying your debts, continue making at least minimum repayments or even more.

Once you have an emergency fund set up, you can then increase your debt repayments, and if you have no outstanding debt, you can focus on investing.

It is wise to save the emergency fund in an account that’s separate from your regular spending account to reduce the temptation to spend the money. You can even invest it in short term government instruments (treasury bills) or even short term deposits in your SACCO.

Finally, only use your emergency fund if it’s an absolute emergency, but whatever you do don’t put yourself into debt because you don’t want to touch your precious savings.

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The aim of this blog is to simplify personal finance.
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1 Comment

  1. [BLOCKED BY STBV] Should You Prepay That Loan?
    August 4, 2014 - 11:29 am