Building an Emergency Fund: How to Set a Budget When You're in Debt

Budgeting Financial Advice


7 min. read

By: FCU Team

Did you know that the average American has roughly $38,000 in personal debt, and that doesn't even include their mortgage? Being in debt can feel suffocating and crippling, like a hole you can't escape. However, it doesn't have to be that way. With careful budgeting and planning, you can both pay off your debt and build an emergency fund. Let's take a look at how.

Creating a Budget

When you're in debt and want to build an emergency fund, the first thing you're going to want to do is create a budget. This step can help you understand where your money is going and ensure that you're saving what you need. So what's a budget? Simply an estimate of your income and any expenditures.

How Much Do You Earn Each Month?

The first step in creating a budget is to look at how much money you're making every month. Add up any income you make, including paychecks, salary, child support, rental properties, alimony, investments, or other types of income.

If the amount of money you make fluctuates month to month, you'll want to come up with how much you make each month on average. If your income fluctuates, consider leaning on the conservative side so you are confident that you can pay for your necessary expenses in months with tighter incomes.

What Are Your Necessary Expenses?

List out all your necessary fixed expenses such as mortgage, rent, utilities, minimum debt payments, cell phone bills, taxes, car payments, groceries, medications, insurance, childcare, and transportation costs. Things like your music streaming service or Netflix don't belong on your list of necessary expenses. This list is for necessary expenses to keep a roof over your head, food in your fridge and pesky creditors at bay.

Take a Look at Past Spending

Take a look at how much you usually spend in each category month to month. Look at your debit and credit card statements and tally up how much you spend on groceries, eating out, coffee, household items, subscriptions, etc. If you usually buy things in cash, start keeping receipts or buy a small notebook to jot down where your money is going. Once you have a month of data, you can categorize where you’re spending your cash.

List Your Non-Essential Expenses

Now it's time to make a list of the things you spend money on that aren't essential. Be honest about where you spend your money and check for the sneaky culprits like the couple of extra items you throw into your cart while grocery shopping. Include things like entertainment, dining out, gym memberships, pet expenses, streaming subscriptions, and clothing.

Draft a Budget

Now it's time to make a draft of your budget. Break your spending down into categories and allocate a specific dollar amount to that category each month.

Using either an excel spreadsheet, a budgeting app or a piece of paper, write down your total income and the amount of money you spend on necessary expenses.

Then, list your non-essential expenses and write down how much you've been spending on these each month. Here's where you can start trimming the tree a little bit. Try to decide where you could spend a little less money each month. For example, do you usually spend $100 on clothes each month? Could you cut this down to $50, or even forgo it entirely for a few months? Once you've made decisions about your non-essential expenses, list out the categories, and write down your proposed budget for each one.

Now that it's all written down, add up all of your expenses. Are you spending more or less than your total income? If you're still spending more than you're making, you're going to need to make some more cuts in your non-essential budget.

How Much Should You Have Left Over?

A common rule of thumb is that you should be ideally saving 20% of your monthly income for savings or to pay off debt. This rule means that if you make $2,500 every month, you want to have $500 leftover after you've paid all essential and non-essential expenses.

Though it can be challenging if you are living paycheck to paycheck, the ideal ratio to go by is 50-30-20. This ratio means that you should be spending 50% of your income on your essential living expenses, 30% of your income on non-essential expenses, and 20% going towards savings and debt payments.

What If You Don't Have Anything Left Over?

Saving 20% of your income every month might seem like an impossible task but remember saving some is better than saving none at all. If you're living paycheck-to-paycheck and not building any savings or paying down your debt, you're going to have to make some changes.

There are two options for creating an outcome where you save money each month. The first is that you can find a way to make more money. It's easier said than done, but it might be time for you to pick up more hours or try to find a better paying job.

You can also try and get a second job or start a side hustle. Other options include selling some of your belongings, asking for a raise, or doing odd jobs for cash.

The second is to spend less money each month. Could you cut down your grocery bill a little bit or cut your Netflix subscription?

Try to hold off on making purchases like upgrading your car or cell phone before it’s essential. Focus on your emergency fund and getting out of debt first, then you can start setting aside money for other goals. When you're trying to get out of debt, you have to be creative and be willing to consider options you otherwise wouldn't.

Methods for Keeping Track of Budgeting

Not everything is going to work for everyone. There are several different ways you can create your budget and track your spending. The first option is a traditional spreadsheet. You can use your computer to fill out your expenses or print off a spreadsheet to input them manually. Another option is keeping a bullet journal. Keeping a physical journal can help if you worry you won't use a budgeting program on your computer or phone.

There are also several different apps you can use for budgeting if you'd prefer. Some of them even link to your bank account, so your spending is automatically tracked. If you worry about whether or not you'll consistently write down what you've spent money on, this might be the right choice for you.

Setting Up an Emergency Fund

An emergency fund can ensure that you stay out of debt in the years to come. This way, when an emergency expense comes up, it won't leave you with crippling debt. Having an emergency fund isn't a luxury, it's a necessity. There are always things that can come up in life to bump you off your horse and an emergency fund is a safety net.

If you need to repair your car, you have an unexpected health issue, or you need to find a new apartment on the fly, you'll have a buffer, so the event isn't financially crippling. You'll want to save a small emergency savings fund before you start trying to tackle your debt.

Start by saving enough to cover your expenses for a month if you weren't making any income for one reason or another. The goal is to save up three months' worth of your monthly income. The way you'll get there is by setting aside the difference between your income and what you spend each month into a savings account. You can even set up an automatic transfer so it will happen automatically.

If possible, you'll want to keep your emergency fund in an interest-earning savings account. While the interest you make on your savings won't be much to write home about, it's better than accruing no interest at all.

While it might seem like the amount of money you should save for an emergency fund seems high, when you set aside a little every month it starts to add up.

Treat your emergency fund savings as a monthly expense, make a habit of transferring money into your emergency savings account right away. By setting aside money at the beginning of the month, you’re paying yourself first.

Follow Your Budget

It's great to have a plan, but now you need to implement it. It can be challenging to stick to a strict budget, but you're going to want to do the best you can. Remember, if you have a bad month, don't bounce off it completely. Get back on track and do your best to follow your budget as soon as you realize you’ve gone overboard.

Coming up with a goal can be an excellent way to stick to a budget once you've made it. Once you have your debt paid off and created your emergency fund, what do you want to do with your money? Are you hoping to buy your first home or a new car? Do you want to take a European vacation in the next year?

Choosing a goal to work towards can make it easier to stick to a budget. This way, when you're tempted to spend money outside of your allotted budget, you can remember why it is you're saving in the first place.

Need help following or building your budget? Our online and mobile banking platform has various easy to use and useful financial wellness tools perfect for those looking to save.

Should You Pay Your Debt or Save?

This question can be hard to answer. You'll want to look at your debt's interest rate and consider whether it's better to pay it off in installments or pay it off early. Sometimes, debt with a low-interest rate is better to chip away at slowly, so you can put more into savings.

Frequently, though, the interest rates on people's debt are relatively high. This issue means that once you've saved up your emergency fund, you're going to want to tackle your debt head-on.

Setting a Budget to Pay Off Debt and Build an Emergency Fund: You Can Do It!

Learning to stick to a budget can be challenging, but it's essential if you want to pay off your debt and build an emergency fund. Digging yourself out of debt is possible with a little bit of planning. Creating an emergency fund is a way that you can protect yourself from ever falling into debt again. Putting your emergency fund in a savings account is one of the best ways to have a safety net when you most need it.

If it's time for you to set up a bank account to start building your emergency fund, Florida Credit Union is here to help. Feel free to contact us today if you have any questions about our services!