Emergency funds: how much to hold, and where to keep it

The short answer

An emergency fund is cash you keep aside so an unplanned bill does not become a debt. It sits somewhere you could reach within a day or two, and somewhere you are not going to spend it by accident. That is the whole of the idea, and every argument about it is really about the size and the location.

A rule of thumb gets quoted almost everywhere, expressed as a number of months of living expenses. It is a reasonable place to start a conversation and a poor place to end one, because the households it is quoted at have very different incomes, dependants and commitments.

The useful version of the question is not how much in general. It is how long your household could carry the payments that do not pause, with nothing arriving, and how quickly you could reach the money if that happened next week.

What a lender reads in your savings

A lender assessing a home loan is not only counting your deposit. It is reading the statements the deposit sits in, and what those statements show about how you run a month.

The policy term for the first part is genuine savings, and how a deposit was built commonly matters as much as how large it is. That is covered in full at /guides/save-for-your-home-deposit/, so it is enough to say here that a balance accumulated steadily is read differently from the same sum arriving last week.

• A balance built up over a period is commonly treated as evidence you could meet a repayment
• Dishonours, overdrawn accounts and late payments are visible on a statement and they are read
• Card and consumer debt is commonly assessed at the credit limit rather than the balance, whether or not the card is used
• Some lenders want to see funds remaining after settlement, particularly where the deposit is small or the file is tight
• A construction file commonly attracts more attention on this, because building costs rarely land exactly where the budget said they would
• What counts, and how much of it, is set by each lender's own policy and changes without notice

None of that is a test of character. It is a lender working out whether a repayment would still be met in a month that goes badly, and a buffer is the most direct evidence of that anybody could put in front of them.

Working out how much to hold

Start from your commitments rather than from your income. The figure that matters is what leaves your account whether or not you are working, and that is a shorter list than most people expect.

1. 1

   Add up what has to be paid regardless

   List the commitments that do not pause because your income does: the mortgage or the rent, rates, insurance, utilities, minimum loan repayments and food. Leave out everything you could genuinely stop, because a buffer sized against your good months is a buffer sized against the wrong thing.

2. 2

   Decide how long you would want to cover

   This is the judgement, and it is where the honest answer is that it depends. A household with two stable incomes and nobody depending on them is in a very different position from a single income supporting a family, or from commission and contract work where a quiet quarter is normal.

3. 3

   Set a first milestone rather than the whole target

   A fund large enough to absorb one ordinary shock without borrowing — a car repair, an insurance excess, a vet bill — is worth more than a perfect target you never reach. Most people give up on the target and would have kept going on the milestone.

4. 4

   Make the saving happen before the spending does

   A standing transfer on payday into an account you do not carry a card for beats intention every time. The account being slightly inconvenient to reach is a feature rather than a problem.

5. 5

   Revisit it when your commitments change

   A new mortgage, a child, a car loan or a move to self-employment all push the figure up. Paying a debt out moves it the other way, which is worth noticing rather than letting the target drift upwards forever.

What argues for holding more is anything that makes income less certain or commitments harder to pause. Variable, commission or contract income, self-employment, a single income, dependants, an investment property that could sit vacant, and a household with no income protection all point the same way.

What argues for holding less is the opposite, and also genuine access to other money. Redundancy or sick leave entitlements, a second stable income and low fixed commitments could each mean a shorter period of cover is enough for you.

Where to keep it

Two things decide where a buffer should sit: how fast you could reach it, and how easily you could spend it on something that is not an emergency. Those pull against each other, which is why the answer is usually a separate account rather than the one your card is attached to.

For a household with a mortgage there is a second question worth getting right. Money held in an offset account and money sitting in redraw both reduce the interest you are charged, and they are not the same thing on the day you need to get at it.

• A credit card is a debt facility rather than a buffer, and drawing on it in a crisis is the outcome a buffer exists to prevent
• A card limit is commonly assessed at the limit rather than the balance, so a large standby card could reduce what you are able to borrow
• Shares and managed funds could be worth less on the day you need them, and selling them takes time
• Superannuation is not available for an ordinary emergency, and the conditions for early release are set by government
• Redraw is money inside a loan, and it is commonly restricted or unavailable while a loan is fixed
• An account you carry a card for is an account you could spend from without deciding to

Wherever it sits, keep it apart from the money you run the month on. A buffer you cannot tell apart from your everyday balance is one you have already spent without noticing.

Buffer first, or deposit first?

This is the question that stops most people, and there is no general answer that survives contact with a real household. Both goals draw on the same money, and every dollar sent to one is a dollar the other does not have.

What is worth knowing is that the two are less opposed than they look. A buffer built steadily is savings, and savings history is one of the things many lenders read — though whether a particular balance counts towards a genuine savings requirement is that lender's own policy and worth checking rather than assuming.

The case for holding something back is narrow and it is strong. Buying with nothing left over means arriving at the point your commitments are highest with the least room to absorb anything, and a card used at that moment becomes a repayment counted against you the next time you apply.

• Work out what settlement day actually costs, including duty and the costs that fall due alongside it
• Decide what you want left in the account the week after settlement, and treat it as part of the target
• Clear or reduce consumer debt where the interest charged outruns what a savings account pays
• Cut card limits you do not use, because the limit is commonly the figure that gets assessed
• Ask your broker what the lenders you could use expect to see left over, before you make an offer
• If you have to spend the buffer, rebuild it before you add to anything else

Where to go next

A buffer is a savings question with a lending consequence, so the pages below split between the two. If you are working towards a purchase, the deposit guide and the buying costs calculator are the place to start.

If you would rather work it through with somebody, tell us where you are up to and we could set a target against your own position. What any lender would accept remains subject to their approval, to a valuation of the property you choose, and to your circumstances at the time you apply.