5 Tips for Handling Emergency Expenses
Sometimes life throws us a curveball, an emergency expense we are not ready for. Whether that is a car repair, home repair, or unexpected family emergency the one thing that is certain is that these events cost money.
Often this is money that goes above and beyond our normal daily budget. It’s money we don’t have in our checking accounts, but the expenses usually require immediate attention and therefore funding.
What do you do in case of these events? Where does the money come from? Here are five tips for handling emergency expenses.
Use Savings First
Ideally, you should have an emergency savings account. Most financial advisors recommend at least 90 days of living expenses, and preferably six months. That way if for some reason you could not work, you would still be able to afford daily necessities until you got back on your feet again.
Even if you do not yet have this much cushion in your savings, when an emergency comes along, use what you do have in savings first. This is for a number of reasons. The first is that while you were earning interest on that money, it probably was not much, and borrowing from your savings first is better than paying interest to someone else on a loan.
The second is that is the reason you have your savings so that you don’t have to go into debt when something goes wrong in your life. You can replenish savings if need be, and tighten your budget for a few months to replace the money you spend, but it will take even longer to recover from debt and may require long-term budget changes.
Get a Loan
If you absolutely have to in case of emergency, you can take out a loan. Personal loans come in a few types and it is important that you know how these loans work. They are for different terms and carry different interest rates depending on how much you have to borrow.
Loans can be secured or unsecured. Unsecured loans are simply based on your credit score and your ability to pay. They are secured by your signature or your promise to pay. They are usually short-term loans and not for large amounts of money.
The other kind of personal loan is a secured loan. This is a loan that is tied to an asset like your home, 401k or other investments. If you don’t pay the loan, the lender takes ownership of those assets. Interest rates are usually lower on these loans, and the term is negotiable. The amount is usually related to a percentage of the value of the asset.
Personal loans are usually a better way to go than other funding methods, and these loans can come from your bank or another financial institution. If you have good credit, these loans are a reasonable solution
Use Credit Cards
Credit cards are an option, but not always the best one. When you have an emergency though, you often have to reach for the closest ready source of money. Since with the credit cards you already have an approved limit, the money is there for you to borrow. Just be aware of a few things.
- The interest rate: the interest rate on a credit card is most often higher than that of a personal loan. If you plan to pay the card off quickly, that might not be a problem, but long term the money you borrow will cost you more.
- The term: you will have a minimum payment due every month that goes up the more you borrow.
- The credit impact: using your credit card will have an impact on your credit score. If you get close to the credit limit, your score will be affected. If you make late payments even by a few days, the largest factor in your credit score will be impacted negatively.
Credit cards are not your best option, but if you must use them do so wisely and pay them off as quickly as possible once the crisis has passed.
Ask Friends and Family
It is hard to ask people you know to loan you money, but sometimes it is necessary, and while it might be awkward, asking those close to you to borrow money is sometimes essential. Keep these things in mind if you do borrow from friends or family:
- Draw up a contract outlining the terms of the loan, and both of you sign it.
- Make payments on time and communicate. Treat the loan like you would one from any other lender.
- Be honest about what you need. If you borrow too little, you might end up borrowing elsewhere too and not being able to meet your obligations. Borrow too much, and you extend the length and awkwardness of the loan.
Borrowing from friends and family is never ideal, but when you have to treat the lender and the loan with the utmost respect and make paying it back a huge priority.
Leave Retirement Funds Alone
It can be tempting to look at the balance in your IRA or 401k and consider cashing it out when you are in an emergency situation. Don’t do it. You can borrow against those funds, and while there is some risk involved, it does not entail the costs that cashing out a retirement account does.
There are usually fees from the investor who holds the account, tax penalties, and other costs associated with withdrawing from a retirement account.