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Emergency Fund and Debt

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Money is the only game we ALL have to play.

How long could you live if you lost your income tomorrow? 

Over 40% of people in the UK wouldn’t be able to last one month without their income. They are at the mercy of their job, living month to month with nothing left over. 

What happens if the car breaks down and needs an expensive repair? The washing machine stops working. What if your pet needs a medical procedure? The list is endless of things that can creep up on you, and if you don’t have the savings behind you to cover it, if you live month to month, you will be in bad shape with your finances. Therefore having an emergency fund is essential! 

Emergency Fund

An emergency fund is savings. Savings that you only use in case of an emergency. They aren’t for when you want a night out with your friends but can’t afford it. It is not for the cheap deal you saw at the travel agents. Buying takeaways or buying yourself clothes! The discipline to keep your emergency fund safe will help you when the time comes, and something unexpected comes up. 

Having these savings behind you won’t just benefit you financially. Knowing that you have the funds behind you to cover life’s surprises that would ruin most people’s finances and throws them into a debt spiral. That is a weight off of your shoulders, 

So even if you can only afford £20 a month, save it up. Put it away and add it to your emergency fund. Open a dedicated pocket on PLUM APP, which I have done an in-depth review on and will be released asap! The aim initially should be around £1000. But, once you can get to this, 3-6 months of living expenses is ideal. If you have completed your BUDGET PLANNER FROM PART 1, you will already know your living expenses for a month. If you aren’t sure what it costs you to live every month, I would look back at part 1 and complete the budget planner. 

Do I need an emergency fund?

For some people, this may be unnecessary. You may have a secure job, or you won’t be taking any risks that you may require a few months of income. If your job is genuinely safe, I would make sure you have the £1000 to cover the real short-term emergencies.

But having 3-6 months of expenses saved in your emergency fund is a great safety net. No matter what happens in the future, you can survive that time without an income. It allows you that time to find something else or that time to take a chance on your business. Whatever the reason is, you want to have that security behind you. 

As discussed earlier, an emergency fund is there to be used for emergencies, to help you when you cannot afford something unexpected that comes up. You must work to replace any money that you use. Before you continue investing or buying unnecessary items that you want, get that safety net back under you before you continue investing. Who knows when the next unexpected bill will come around the corner, we need to be able to afford it without causing financial ruin! So, make it a priority. 

Debt

It’s a word we are all very familiar with. I know I certainly am. Debt is like trying to stay afloat with an anchor tied to your feet, it is hard going, and eventually, you will drown if you don’t have your finances in order. 

I have been in a debt spiral before. It is probably one of the lowest points in my life. We had a wedding to pay for, we had our first house and a new car, and we spent money like confetti. We were going round and round, struggling through each month to get ahead of the game. 

Taking on debt to help ‘clear our feet’ or ‘get us ahead’. 

‘Just put this on the credit card, and we will pay it back’. 

But how do you pay it back when you are already haemorrhaging money every month? The simple truth is, you don’t. And before you know it, you are in a hole with nowhere to go. 

So what do we do? How do we pay off debt? Why should we pay off debt? 

Well, it all comes down to interest. The interest rate is how much money the lenders make off you. The higher the interest, the more you pay. That is pretty obvious, but knowing what % you are paying on a loan or debt makes a big difference. 

Debt can be classed into different categories 

10%+ – RED! RED! RED! These rates tend to be credit cards and payday loan type agreements. These are code red! You need to clear these ASAP! Depending on your credit score, you could be looking at 17-20% APR; this is bad for your financial health.  Some payday loan deals can be 25%+, truly scary APR.

5%-10% – Amber! These are still high but not as crushing as payday loans and credit cards. 

1%-5% – Green – These are generous rates that are easier to pay off as the interest level is lower, so more of your capital goes to paying off what is owed. 

So we know what debt is better than the other kinds. But how do we deal with them? There are a few strategies you can try. 

  1. List all your debts and their APR %. 
  2. Target the highest APR ones as the ones to clear off first. 
  3. Talk to ALL your lenders and try negotiating on the interest %. 
  4. Put everything EXTRA you earn into the highest interest debt. 
  5. Once the highest is cleared off, you target the second-highest. 

By targeting the high-interest debt first, you accomplish a few things. 

  • You create a measurable goal that you can focus on.
  • Once it’s paid off, you start a debt repayment compounding snowball! In other words, the money you were using to pay off the highest interest debt is now going towards the 2nd highest. Once that is paid off, you target the 3rd highest with the amounts you paid into the first two. 
  • This compounding will gather pace as the debt clears, and you will pay off each one quicker than you would have to try to target them all together. 

Good debt?

Not ALL debt is bad! The debt mentioned above is detrimental to your financial health for sure. But not all debt is created equal. 

Think of it this way, what are you paying the debt on? If you are paying the debt on a credit card that paid for your holiday, then yeah, that’s bad debt and needs to be cleared asap. But what if the debt was making you money every month? That is the difference. 

You are taking out a mortgage on a second property, for instance. Your tenant pays you to rent out the property every month, which covers the mortgage and leaves you with a few extra pounds in your pocket. On top of gaining the excess between the mortgage and rent, the property can also appreciate. Property investment is more complicated than this, and you do have other overheads that you need to cover as a landlord. But I want to get you thinking slightly differently about debt; it can and is used by people to make themselves money. 

The steps to FI so far…

So, we have now gone through 5 key steps towards Financial Independence.

  • Tracking expenses
  • Cutting expenses
  • Increasing your income
  • Creating an emergency fund
  • Paying down debt

What all these steps do together is create a gap in your finances. The gap is the difference between your expenses and your income every month, the money you have leftover. It is what we do with this gap that makes the magic happen.

We’ve covered the five steps in detail so far, but there are two more, and we will cover them in our next post, Invest to FI! 

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