The only way to get out of debt is to stop going into debt. You can’t fill a hole while you’re digging out the bottom. What does this have to do with an emergency fund?

Well, let’s pretend that we’ve done our budget and now we jump straight to throwing all available cash at paying off debt. We have no emergency fund at all. Now the transmission on the car goes out and that is the only way to get the kids to school, dad to work, and groceries home from the store. You can’t go without the car. (Let’s not even talk about the state of public transportation in the U.S.) You have to get the car fixed, but $600 is too much cash to come up with on a moment’s notice. So out comes the “For Emergencies Only” credit card. The hole just got dug a bit deeper. Now we’ve fixed the car and the hot water heater decides to empty its contents into the laundry room. I don’t even know how much a new hot water heater costs nor do I know how much it will cost to repair the damage caused by the associated mini-flood. But where does that cash come from?

So what do we do? Well, if you had setup an emergency fund before starting your debt reduction plan, you could have paid cash for those emergencies rather than go further into debt.

Dave’s Baby Step One calls for $1,000 in the bank in what he calls a “Baby Emergency Fund.” A $1,000 is not enough for a real emergency fund, but while we are working to get out of debt, it will provide the short term buffer we need.

Where should this money get put? Well, it needs to be easy to get to in case of emergency, but not so easy to get to that a trip to the supermarket gets classified as an emergency when the budget for food is running low.

A great place to put this is a money market account that has check writing privileges. Bankrate.com is a great site to use to search for money market accounts based upon features, rates, locations, etc. Personally, we use GMAC Bank for our emergency fund. As of November 26, 2008, they are paying 3.2% APR on their MMAs. You can access your account online and transfer funds from your checking account into your MMA. You get checks and a check card for account access.

Once your $1,000 baby emergency fund is in place, it’s time to move onto Baby Step Two…