When it rains it pours isn’t just the Morton’s slogan. Many people find – fortunately or unfortunately — it’s also the way life goes. That was true for Gina, diagnosed with cancer shortly after losing her gig as an independent contractor. While you can’t plan for these individual events (or, I suppose you could try, but it would be a real bummer) you can – you should – plan for emergencies in general.
I’ve written often in this space that you should aim to have a liquid emergency cushion of three to six months living expenses to tide you over in cases just like this. And I do believe that’s optimal. But there are some times when it seems impossible to amass this much money, and others when it seems like other financial to-dos take priority. So this week, we discuss emergency cushion nuances:
Which takes priority – building up an emergency cushion or paying down debt? Particularly with interest rates on savings as low as they are now, you get a much bigger financial bang by paying down debt. And, as long as you keep your credit lines fairly open, if you have a real emergency you can put it on a credit card. However, not having any liquid savings pretty much ensures that every little emergency will end up costing not just its price tag but interest as well. So, I’d split the difference until you build up a few thousand dollars. Then wail on your credit card debt until it’s gone. Then go back to funding your cushion.
Where should I put my emergency cushion? I understand that low savings rates are frustrating (on the flip side, low mortgage rates have brought a lot of people a lot of joy) but that doesn’t mean your emergency fund belongs in a place other than a savings or money market account. Why? Because not only do your emergency savings have to be liquid and free from risk, they have to be accessible. In other words, you have to be able to get at the money if and when you need it without jumping through a lot of hoops. For that reason, a bank with a local branch you can actually walk into may be your best bet.
How about using a line of credit instead? I like having a home equity line of credit as an additional emergency cushion. It doesn’t cost much (if anything) to establish, you don’t actually borrow the money unless you need it, and so you never pay interest until that happens. It’s not a substitute for nice chuck of cash. But if your cash cushion isn’t at the three to six month level, or even if it is, it’s nice knowing that you’re doubly covered. Just note: If your emergency is a result of unemployment, this is not a move you can typically make once you’re out of the workforce. Lenders will want to see that you have the income to support repaying the loan.