Maybe that fortunate 1% doesn’t have to worry about financial emergencies but the other 99% of us do. Whether we like to believe it or not we will all be faced with some kind of financial emergency in the next couple of years. The transmission might fall out of our car, you could be hospitalized with a serious illness or your ceiling could collapse from water damage. And of course, the biggest problem with a financial emergency is it’s just that – an emergency. It’s not something you can plan for outside of having an emergency savings fund.
Note: If you don’t have an emergency fund at all, here’s a video showing how to build one.
The worst thing you can do in times of a financial emergency is panic. Sit down, get control of yourself and assess the situation. What often scares us the most is the unknown. Don’t start running around like a headless chicken. Think about the situation rationally. There’s a solution to every problem if you just keep calm.
Assess the situation
Your next step should be to rough out a plan. How much has this cost you? Do you have to pay for it immediately or could you spread out the payments over several months or years? Could you pay for it yourself out of your regular income or would you need extra money? Do you have credit cards you could use? Would you be able to get terms – in other words would the hospital, garage, construction company or whatever allow you to pay off your bill over a period of time or will it require immediate payment? While hospitals are often willing to negotiate payment plans, auto repair shops usually won’t.
Decide how to pay for the emergency
You need to decide how you could pay for your emergency as quickly as possible so you could get back into good financial health. There are basically two ways to do this. You or your spouse could get a second job and use the money to pay for that emergency or you could borrow the money. The best option is to get a second job, as this would prevent you from having to pile on new debt. Our economy has been bouncing back over the past year and one of you should be able to find a part-time job. It might not pay more than $8 or $10 an hour but if you use all of the money to pay for your emergency, you should have it paid off in practically no time at all. Alternately, you might be able to start a home-based business and earn what you would need to pay for that emergency.
If you have to pay for your financial emergency immediately so that you would not have enough time to pay for it with a second job or home-based business, you will need to borrow the money.
Why a credit card(s) could be a bad option
The way most people pay for an emergency is by using their credit card or cards. For example, suppose that the transmission had fallen out of your car at a cost of $3500. You could probably put this on just one of your credit cards and your problem would be solved – at least so far as the auto repair is concerned. But you’ve now added debt – that might be at a very high interest rate. Do you pay 19% interest or even more on that credit card? Then using it could be a very expensive option.
Tap your retirement account
Do you have a 401(k) or some other type of retirement account? You could borrow from it but you need to pay back the money as quickly as possible. There is a good reason for this. When you borrow money from your retirement account it’s no longer growing in value so that you’re missing out on the power of compounding interest. And if you don’t ever pay the money back, you will ultimately be taxed on it as ordinary income and may even have to pay a penalty.
Ask friends or family members
Could you borrow from friends or family members? This can be a bit embarrassing but it might be your best alternative. If you can borrow the money, make the transaction very businesslike. Write a contract with your friend or family member just as if you had borrowed the money from a bank or credit union. It should spell out how you will pay back the money and, of course, the interest you’ll pay.
If you have other outstanding debts, you might be able to get a debt consolidation loan and pay them off as well as for your financial emergency. Depending on the total amount of your debts, you may be able to get an unsecured loan. Or if you have a fair amount of equity in your home, you could get a secured loan such as a home equity loan or homeowner equity line of credit, which should have a much lower interest rate than an unsecured loan.
File for bankruptcy
If your financial emergency was an illness or accident that ended up costing you thousands or even hundreds of thousands of dollars in hospital bills, you might think about filing for a Chapter 7 bankruptcy. This would get all of your unsecured debts discharged in probably six months or less. For that matter, medical bills are now the number one reason why people file for bankruptcy. But before you take this step, do understand that there are long-term consequences to a bankruptcy that would haunt you for years to come.