Unexpected Expenses: How to Prepare & Pay for Them
Paying for unexpected expenses can be difficult, especially when you are either unemployed or tight on cash. With that said, there are several steps you can take both while employed or unemployed that can help you to navigate this difficult and often stressful situation. Remember, these general concepts can help to guide your thoughts in this process, but seeking the guidance of a financial professional is always wise when making any sizeable financial decisions. Only by running a financial plan for your specific scenario will you be able to tell how your decision will influence your personal financial picture.
Savings
When you do have income and times are good, be sure to create savings goals and commit to them. Your savings goals should be formatted as SMART goals, meaning they are Specific, Measurable, Attainable, Relevant, and Time-Bound. Making a commitment to your savings can help you to manage unexpected future expenses, sudden loss of income, a family emergency, and much more. The general guidance is that you should have enough cash in your savings to cover 3-6 months of expenses. In addition, some individuals like to keep an small savings account with funds for upcoming or unexpected expenses. Below are steps to get yourself set up for success as it relates to savings.
Emergency Fund: The first step is to build your emergency fund. This should always be the first step when considering saving, investing, or otherwise. While the standard guidance is to have enough cash to cover 3-6 months of expenses, it will depend on your comfort level. Some people may require enough cash to cover 9 months of expenses to feel at ease.
“Sinking” Fund: Next, many people benefit from establishing a “sinking fund”. A sinking fund can help you to pay for an expected or predicted upcoming expense. For example, if you know that you will need to have your driveway repaved within the next year and it will cost between $2,000-$3,000. You can now break that number down across the number of months remaining until payment is due and save each month to meet this goal, i.e. $167 - $250 per month.
Taking these strategic steps when you’re in a position to will better enable you for success in potential times of hardship. As the saying goes, “Prepare for the worst and hope for the best.”
Spending
If at all possible, put any non-essential spending on hold while unemployed or struggling to make ends meet. If you have any unnecessary major purchases planned, it might be wise to delay these expenses until you have a better sense of when you might again have stable income and disposable cash.
Take Inventory
If you are currently out of work, this could be a good time to sit down and take inventory of all your expenses. Remember this age-old saying from Benjamin Franklin, “Beware of little expenses, a small leak will sink a great ship.” Yes, those small and hardly noticeable monthly expenses such as lattes and subscription services are often those that can add up, hurting your budget in the long-term.
Work with Lenders
You might be surprised to know that there are options for those suffering from a loss of income. Call your credit card companies and other lenders and ask what options you might have, particularly if you have an excellent payment history. Be sure to do your research as there is no guarantee these options won’t impact your credit score.
Find a “Side Hustle”
In our modern world, there are many options for those seeking a job in the gig economy. You might be able to find a job doing food or grocery delivery, pet sitting, babysitting, house cleaning, and more. While it is not ideal for everyone, this additional or supplemental income can often help to get you through an unexpected expense and get back on your feet.
Sell Unneeded Assets
A final option might be to sell some assets of value that are non-sentimental and non-essential. While this is often a last resort option, modern technologies—such as Poshmark or Facebook Marketplace— allow for the easy sale of goods and services online for quick cash.
What if the emergency cost is occurring now?
Option #1: If you have emergency savings and the expense cannot be delayed, this might be a wise time to tap into the emergency fund. After all, that is what savings are for. Consider these questions when determining if you should use your emergency fund, “Do I need this?”, “Can I no longer delay this expense?”, “Is this a true emergency?”. If the answer to these questions is “Yes” then it is likely a good time to use your emergency savings. Just be sure you replenish the funds as soon as possible to ensure you are adequately equipped for the next unexpected expense that comes your way.
Option #2: Consider all of the steps above. This might include looking for a side job to work a couple nights a week, cutting out any unnecessary expenses, and working with any lenders who might allow you to delay your payments for a month or two. If you have a history of excellent payment on your accounts, it is possible your lender might be willing to work with you in the event of an emergency.
Final Options: When none of the above is sufficient to help you meet the costs of the expense, there are other options. In an emergency, many people will turn to either a short-term personal loan or a 0% interest credit card. While neither is an ideal option, they are an option in the event of an emergency. But, before choosing either of these methods, the pros and cons of each should be carefully assessed in line with your personal financial situation.
Short-Term Personal Loan: Taking on a short-term personal loan can help to ease the stress associated with a single unexpected financial expense. With that said, a loan is not always the best solution. You should always ensure that paying back the loan will not exhaust your budget. Additionally, this is likely a good option for an individual who does not have too much existing debt. If you already have several unpaid balances on credit cards, a mortgage, and a car loan, this is likely not the best financial choice and you might not even qualify for a short-term loan with reasonable terms. If approved, be sure to carefully read and understand the agreements of your loan to avoid unnecessary and unexpected costs.
0% Interest Credit Card: For many people, a 0% interest credit card can serve as a useful tool to cover an unexpected expense or lower high-interest balances. This can be even more fruitful if the credit card offers any sort of promotion for large purchases, travel points, or cashback rewards. With that said, as always, it’s important to ensure you fully understand the term of your credit card before deciding if this is the right option for you. For some 0% credit cards, the lender reserves the right to end the introductory 0% period if you make a late payment or don’t pay your minimum payment. You may even be subject to a penalty APR which can soar as high as 30%. Be sure to keep in mind how long your 0% interest period is on the card. Do you expect your income will return to normal by the end of that period? If not, a 0% credit card might not be the best choice. The last thing you want is to be hit with an unexpected interest charge when the promotion period comes to a close.
So, which is best?
If you are forced to choose between a short-term loan and a credit card with a 0% introductory period, it’s important you assess your individual financial situation. No single answer is a universally better option. Some factors to consider are:
The size of your expense: Personal loans might go as large as $100,000 which could be appropriate to cover a business expense or a large personal expense. As you likely know, even if you found a lender to approve you for such a lofty credit card balance, it would be very unwise to charge such a large expense when you are without income. For smaller expenses or reoccurring expenses, a credit card is likely the best option.
Expense Frequency: If the expense is likely to reoccur, a credit card is likely a better vehicle for this expense than a personal loan. A loan is a better vehicle for a one-time purchase that you plan to pay off over time such as a medical procedure or a necessary car repair.
How fast can you repay your loan: Consider the length of the introductory period on a credit card versus your predictions for the next 6-12 months. Is it reasonably likely that you will be able to repay the balance by then? If the answer to this question is no, then it’s possible that a personal loan could be the better alternative as the balance is stretched out over a period of several years as opposed to several months.
What would the credit line be on the credit card: It is unwise to utilize more than 30% of your available credit line on a credit card as it can hamper your credit score. For this reason, knowing your current credit score and how much you’re likely to be approved for can help you to decide if your expense is too large for a standard credit card. In this case, a loan may be the better choice.
What is your interest rate: Be sure to compare the post-introductory interest rate on the credit card with the interest rate offered for a personal loan. This can help you to decide if one vehicle is a better option than the other.
Simplicity: For many people, simplicity is the deciding factor that leads them to choose a personal loan over other alternatives. While a loan can be simple and easy to roll all of your debt into one credit line with a set monthly payment, it is only wise to do so if it will save you money in the process. Be sure to do your research or consult with a financial professional to help you weigh the costs and benefits of doing so.
Conclusion
We know the stress associated with unexpected expenses can be substantial, particularly in tough financial times. As always, if we can be of further assistance, please feel free to contact our team. We hope these tips help you to prepare and pay for any unexpected expenses you might face in the coming year.
Written by Kaitlyn Keeler
Kaitlyn is an enthusiastic client service intern that assists our advisors with your accounts. She is an attentive business student with a concentration in finance.
