When we first began our journey out of debt, we had no clue how to get started.  So we decided to read every book, magazine, and website that we could find on subject, looking for common threads.  The more knowledge that we consumed, the more that we started to see a pattern emerge.  According to the financial experts, the very first thing that should be done is the creation of your emergency funds.

We had never even heard of the concept before, likely believing (as many folks do) that our credit cards themselves can serve as an “emergency fund” of sorts.  Looking back,  I think that this was the single most important change that we made.  I would even say that it may be impossible to get out of debt without creating emergency funds.

What Are Emergency Funds?

Emergency funds are nothing more than savings accounts that can only be touched in the event of an emergency.  Of course, you can create a savings account anywhere, but I would recommend using an online bank for your emergency fund.  This will create a situation where you need a few days to transfer money over from your account, thus helping to make sure that it is a true emergency.

Do this  BEFORE Starting to Pay Down Debt

It seems a bit counter-intuitive that the first thing that you should do when trying to get out of debt is to start *saving* money. After all, those huge credit card balances that you are carrying are going to continue to rack up interest, and they certainly aren’t going to pay themselves off.

But the truth is that even if you make some minor gains in paying down debt, you will eventually have another “emergency” that will force you to pile that money right back on the top.  When you are paying down debt, your goal HAS to be to avoid using credit cards FOR ANY REASON.  Without emergency funds in place, this just won’t happen.

How Much Money Do Your Emergency Funds Need?

When I first heard financial experts talk about emergency funds, she mentioned needing several MONTHS worth of salary to cover you in case you lose your job. While that would certainly a good reason to set some money aside (especially in this economy), you need to start much, much smaller.

My advice is to aim for $1000 in this account to start.  Once you pay off your credit card debt, you can (and should) bump up this total.  $1000 is enough to cover most car repairs, most home repairs, most medical co-pays, etc. While it is certainly possible that you could have emergencies crop up that cost far more than this (and we have), your goal here is to build a basic safety net.

When Is it Okay to Use The Money From Emergency Funds?

The definition of emergency will vary from family to family, but you are going to have to keep it real.  Try to use a little bit of common sense.  The local department store having a huge sale on purses is NOT an emergency.  Your favorite band coming to town, but charging $100/ticket is NOT an emergency.  However, if a waterspout breaks off your house and requires an emergency repair in order to keep water from flooding your basement, you might need to pull some money out to cover the repairs.  If you come up a little bit short one month and can’t afford to put food on the table, then yes, that should be considered an emergency as well.

If you have to pull money out of your emergency fund, your next priority needs to be re-stocking the account back to its original $1000 level as soon as possible.  You should go back to paying the minimums on all credit cards until you get there, and only THEN can you jump back into debt reduction mode.

Our Saving Grace

Prior to having an emergency fund,  it felt like things were always happening that pushed us beyond our paycheck-to-paycheck lifestyle, and forced us to take on debt. The dentist told us that my wife needed her wisdom teeth out immediately: $750.  A tree fell down in your front yard (blocking our driveway) that needed to be cut, hauled away, and replaced: $1000.  Our primary vehicle wouldn’t pass inspection without a new set of tires: $600.   It is so easy to see, now that we have been through it.  If we would have had a properly funded emergency account when these things had occurred, we wouldn’t have needed to use our credit cards to pay for them, and they wouldn’t have contributed to making our debt problems worse.

We paid off over $20,000 in credit card debt, and there is no way that we could have done it without the use of an emergency fund.   We still maintain an emergency fund today, and are in the process of bumping up the account to handle even bigger emergencies.  The important thing is that no matter what happens, our credit cards are off-limits.

As time goes on, we have gradually shifted our emergency fund from a normal savings account to an online money market account.  You can get a still get the same benefits of hosting your emergency fund in a savings account, but can earn a much higher interest rate.  Deacon Hayes over at Well Kept Wallet recently posted an Everbank Review that outlined the major reasons why money market accounts are appealing.