Do you really need an emergency fund?
Saving for a rainy day means you can cover unexpected costs without getting into debt. Here is how to save and how else you can cover emergency costs.
What is an emergency fund?
Saving up for a rainy day means putting money aside that you can dip into if you need cash in an emergency. It could cover expenses like:
Car repairs
House repairs
An unexpected medical bill, e.g. emergency dental treatment
Paying for basics if you lose your job
Paying your bills if you are unable to work for health reasons
Do you need one?
If you can afford to save a little a month and would not be able to afford the above costs from your wages, it's worth saving an emergency fund.
But it might not be worth it if:
You don't earn enough to put any money aside
You have more urgent costs to cover like debts
You have insurance policies that cover emergencies
How much should you save?
An emergency fund should be enough to pay all your most important bills for several months.
Three months of your usual wages or income is a good minimum amount to aim for.
The exact amount you need depends on your circumstances; for example, you may need more if your partner or children rely on your income.
What else should you save for?
You could also have a separate account if you are saving up for a mortgage deposit or for luxuries like a new car or a holiday.
How to save
The best way to build up an emergency fund is by saving money every time you are paid, e.g. monthly.
The easiest way is by setting up a standing order for a certain amount or a sweeping service. This can move any money you have left at the end of the month from your current account to your savings.
Keep it in a separate account
Keep your savings separate from your main current account so you can:
Keep track of how much you have saved up
Make sure you do not accidentally spend your savings
Earn interest to boost your balance
Choosing an account with a high interest rate means your savings grow quicker, but fixed rate bonds are usually unsuitable. They often don't let you withdraw until the end of the fixed term, even if you need the money in an emergency.
An instant access savings account lets you withdraw some or all of your money whenever you need it without fees or interest penalties.
You could get a higher interest rate by opening:
A regular savings account, which pays interest if you pay in each month
A cash ISA, which is a type of tax free savings account
Pay in extra when you can
As well as paying in regularly, you can boost your savings if you get extra money from:
A raise or bonus at work
Paying off a loan or credit card, leaving you with more money available each month
A tax refund
An inheritance or another financial gift
You could pay this extra money into your savings to build up your emergency fund quicker.
Alternatives to saving
Pay off your debts instead of saving
The interest you pay on your loan, credit card or mortgage is likely to be much higher than the interest you can get on a savings account.
This means paying off your debts could save you more money than a savings account could make you in interest. But raiding your savings could leave you short of money in an emergency.
Here is how to decide if you should pay off your debts with your savings.
Cover your costs with insurance
You can pay for some emergency bills with an insurance policy instead of saving up to pay them yourself. You can cover:
Health problems with critical illness cover, which can cover your bills if you are too ill or injured to work, or health insurance, which can pay your private medical bills
Losing your job with income protection insurance, which can cover your bills if you become unemployed or are unable to work
Expensive property bills with home insurance, which can cover your possessions or your property
Car repair bills with car insurance, which could pay out for damage caused by accidents, theft or vandalism
Insurance policies can make covering a large cost more manageable. But you do not get the money you pay for the policy back if you do not need to claim.
Other ways to cover unexpected costs
If you do not have enough money to pay a bill you could also use a:
These can all be expensive, but using an interest free overdraft or a credit card with a 0% deal on purchases could let you borrow for free, as long as you pay it back in time.
If you get a loan, here is how to work out the cheapest way for you to borrow money.
Help stretch your budget that little bit further by making the most of your savings.