1. PERSONAL FINANCE

What is a Financial Emergency and How to Deal With One

Financial Emergency
Key Takeaways:
  • Financial emergencies are bound to happen to just about everyone eventually.
  • Financial emergencies can be upsetting, but you have options for dealing with them.
  • Comparing costs is one way to choose the best solution.

A financial emergency can blindside even people who keep a strict budget. Sooner or later, it happens to most households—and often more than once. 

A temporary setback doesn't have to turn into a lasting financial problem. You have several options for dealing with a financial emergency. The key is to figure out which is the most cost-effective for the situation.

Common financial emergencies

Financial emergencies break down into two categories:

  • A loss of income

  • An unexpected expense

Below we’ll cover some common examples. Then we’ll go into strategies for handling them.

Job loss

Losing a job can leave you suddenly unable to make ends meet. Having your hours cut may be enough to make it impossible to pay all your expenses. Plus, it can take months to find a new job. Some say one month for every $10,000 of your salary.

Death of a breadwinner

The loss of a primary earner can create a financial emergency. Even if another adult in the household can gain the income to compensate, it'll likely take time. Also, many households rely on two incomes just to get by. Cutting that to one income would leave them without enough money to meet expenses. 

Medical debt

Medical debt (including dental debt) is one of the most common kinds of debt. If you don’t already have debt, you might be at risk of falling behind as the result of a single unexpected health issue. 

Auto repair

Normal wear-and-tear expenses aren't covered by standard auto insurance. Routine things that can go wrong with your vehicle can become a financial emergency. Repairs can cost anywhere from a few hundred dollars to several thousand. 

Home repair

Homeowners quickly learn that property upkeep is never-ending. Replacing a major appliance can cost several hundred dollars. Replacing an HVAC system will probably run into the thousands. Even insured damage usually isn’t cost-free, since most homeowners have to pay a deductible. 

Strategies for coping with a financial emergency

When something goes wrong, it can make you feel helpless. Here are some steps you can take to get control of the situation. 

  • Breathe - and plan. Take a step back to assess the situation calmly. People just like you cope with financial emergencies all the time. You can do it too. 

  • Check your insurance. You might be surprised at what’s covered by your home or auto insurance. Call your provider to ask. 

  • Check your emergency fund or other assets. Do you have an emergency fund or other savings that you can access without penalty? If you do, this is the most cost-effective way to deal with a financial emergency. 

  • Negotiate with the biller. Contact the company you owe to discuss your options. Ask if they will reduce the amount owed or allow a payment plan. 

  • Consider a personal loan. A personal loan could allow you to cover the expense now and repay it over time. If you can qualify, personal loans are generally cheaper than credit cards.  

  • Consider a home equity loan. If you own your home, a home equity loan might cost even less than a personal loan. Plus it might be easier to qualify for.

  • Pay with your credit card. If you have room on your credit card and no other way to cover the expense, you might need to use it. It’s expensive to cover costs this way, so try to reserve this strategy for when you can pay off the balance within a few months. 

  • Use your 401(k). If you have a 401(k), you might be eligible for a hardship withdrawal. You’ll pay taxes on the amount you withdraw and you might also have to pay a 10% early withdrawal penalty. Some employers also allow 401(k) loans, which don’t have a penalty. Any time you withdraw from your retirement account you lose the future growth on that money, which adds to the cost.

  • Government assistance. If a financial emergency makes it difficult to pay your bills, you may be eligible for government help. Federal government assistance is available for rent and mortgage payments, buying food, and paying various other household bills. 

Avoid solutions that'll make the financial emergency worse

Once you’ve considered all the options available, rank them in order of which will involve the lowest cost. Try these first, and then only move further down the list if necessary.

As you go through your options, avoid the ones that are so expensive that they would only worsen the problem. For example, payday loans are so costly that most people have a hard time getting out of them. The average payday borrower renews their loan eight times before getting out of debt, paying a fortune in fees. If you have a credit card, a cash advance is a better option than a payday loan. 

Prepare by building an emergency fund

The best way to pay for a financial emergency is to have the money saved in advance. Of course, making ends meet is hard enough these days. You may find putting aside some extra money for emergencies very difficult.

If you start small, you may find that you can build up a cushion before long. Even saving just $10 a week would leave you with over $500 by the end of a year. That’s enough to take the bite out of some typical unexpected expenses.

Saving any amount involves sacrifices. In the long run, though, voluntary sacrifices may be less painful than a financial emergency that’s difficult to resolve. Knowing you're prepared will help you handle the occasional financial setback more smoothly.

Frequently Asked Questions

How do I save for an emergency fund?

Start small and build it up over time. Set aside money every week, even if it’s just a few dollars, before you spend money on the items in your budget. People who try to save whatever’s leftover after spending often find that there’s nothing left. Pay yourself first.

How much money should I have in my emergency fund?

Start with the goal to save $1,000. The next level will be enough money to cover all of your expenses for three months without any money coming in. Eventually, you want to build this up to six months’ worth. This is going to take time, and unexpected expenses will occasionally prevent you from saving. That’s why your goals should be milestones, not a faraway finish line.

Where should I keep my emergency fund?

Your emergency fund should be immediately accessible without a penalty. That would usually mean in a savings account at a bank or credit union. Choose a high-yield savings account so that you can earn interest while you save. Online banks tend to pay the most interest on savings.