How to Manage Debt in a Financial Emergency

Whether you’re rich or poor, or (like so many of us) somewhere in the middle, you probably have a pretty good sense of what “normal” means for your day-to-day finances. Even if you maintain a consistent debt load and usually have to tighten your belt at the end of the month, well, that’s your normal. If you have a detailed budget and you’re executing a plan toward better financial health, then you’re being proactive by working toward a new normal.

But normal is never guaranteed. That budget you painstakingly calculated down to the last penny? Your ambitious plan for paying off your student loans ahead of schedule? They’re great for normal times but don’t necessarily account for the unexpected. When financial emergency strikes, such as job loss, the death of a spouse, or even a global pandemic (such as the novel coronavirus outbreak of 2020), it’s important to focus on those things you can control right now.

Regardless of what you consider normal, there are times when you’ll have to make key adjustments in order to balance your budget and manage debt in an emergency. From paying your bills on time and prioritizing debt payments, to getting professional help when needed, the following tips will help you manage your money in a financial emergency.

Take stock of your financial situation

It’s impossible to know where to start if you don’t have a clear picture of your current situation. Ideally, you’re not waiting until a financial emergency strikes to get organized; but even if you already have a budget, you’ll need to update it based on new realities. If you don’t have a budget, then you should start there.

The Emergency Financial First Aid Kit (EFFAK) provided by the U.S. Federal Emergency Management Agency (FEMA) recommends that households start by assessing and compiling important financial information, including documents and contacts. FEMA also advises U.S. households to request direct deposit from their employers and automatic payment of any federal benefits to eliminate unnecessary tasks, ensure prompt payments, and (in the event of an outbreak or other such danger) avoid contact with others.

For this initial assessment stage, you’ll want to take the following actions (see the EFFAK in its entirety for more details):

  • Per FEMA’s suggestions, gather your legal documents (such as trusts and powers of attorney), identifying documents (i.e., Social Security cards, birth certificates), medical documentation (including emergency contacts and insurance information), and all financial documents (including tax returns and government benefit statements).
  • FEMA’s fillable household finance worksheet is a great way to organize your finances and includes tips for how to deal with each, including spaces for bank account and insurance policy information, medical details, and more.
  • Print or download statements of any bills you pay automatically.
  • Make sure you have the latest online banking apps installed and registered, which will make it easier to access your records.
  • Make a record of valuable possessions using photographs or video (which will be helpful in the event of relocation or housing destruction caused by a natural disaster).
  • Obtain an up-to-date FICO score.

Once you know where you are financially, you can consider your current and future challenges and make a plan accordingly.

Cut costs and improve your financial health

Most of us have subscriptions to services we never use (when’s the last time you were at the gym?). But even if you do go to the gym regularly, for example, perhaps you could spend some money on barbells and a yoga mat and cancel your membership. Are you still buying lattes at the coffee shop? Maybe it’s time to start making your own. If you’re eating out, then learn how to make a few simple meals at home. If you’re a renter, is there an opportunity to negotiate with your landlord for better terms?

This could be a good time to maximize your liquid assets, not only cash (i.e., checking and savings accounts) but other accessible assets such as:

  • Gift certificates, gift cards, and awards points
  • Matured certificates of deposit (CODs)
  • Money market funds
  • Items that can be resold or traded
  • Food in your pantry

Are you paying your bills on time? Twenty-six percent of Americans carried credit card balances of more than $10,000 in 2019, according to a Freedom Debt Relief survey. Balances carried from one month to the next incur steep finance charges and it’s not often possible to pay the balance off in full each month. But late payments can really hurt. If you’re more than 30 days late, credit card companies may charge a penalty interest rate of up to 29.99 percent of the past due balance.

You’ll also want to audit your insurance policies (including property coverage), keeping in mind that going without adequate coverage can be very costly. And, as with any facet of household budgeting, make sure you’re getting the best rates for the level of coverage you need.

Here are some important things to consider when auditing your home/renters, automobile, health, and life insurance coverage:

Home/Renters Auto Health Life
Rider for expensive items, such as jewelry or high-value antiques? Collision too high or too low? Or perhaps not even necessary? How high is my deductible? How does it square with my typical annual health care needs? Change for age, children, changing health conditions?
Additional flood or earthquake coverage? Update zip code to change rate? Do I have (or need) a health savings account (HSA)? Update beneficiaries?
Remove covered drivers?

The nature of your emergency and an understanding of your current finances will determine the way forward, but cutting costs first is absolutely crucial. If you planned ahead and put together an emergency fund, this could be the time to tap into it.

Prioritize Debt Payments

If you have a clear assessment of your finances and have already cut expenses, then you’re off to a great start. The next step is to prioritize your debt payments, setting apart unsecured (i.e., credit cards, student loans) and secured (i.e., home and car) debt. Secured debt is tied to a particular item, such as a house or car, which can be foreclosed upon or repossessed in a worst-case scenario. Unsecured debt consists primarily of credit cards, medical debt and the like.

While it can seem like an advanced mathematics problem, the best approach to prioritizing credit debt is the so-called “snowball” method, according to a Harvard Business Review study. This is a modification of the popular “avalanche” method in which you organize your credit cards and other unsecured debts by interest rate from highest to lowest, paying the minimum amount each month with any extra you’re able to pay going to the debt(s) with the highest rate.

Mathematically, the avalanche method is the most effective; however, the snowball method has proven most successful for consumers, mainly because it encourages discipline. Here’s how it works:

  1. List your debts, smallest to largest
  2. Pay the monthly minimum for each one, except for the smallest debt
  3. Dedicate as much money as you can to the smallest debt until it’s paid off
  4. Move on to the next-smallest debt and repeat

There’s no one-size-fits-all solution and some people may have more success with the avalanche method. But while the snowball method provides clearer milestones (i.e., reducing your total number of debts), the avalanche method requires more discipline and may take longer to show signs of progress.

Totaling roughly $1.6 trillion in the United States alone, student debt is a big concern for a lot of Americans. While it’s particularly difficult to have student loan debt erased, there are some steps borrowers can take to help them manage their payments. These include:

If you’re a homeowner, then your mortgage likely will be the last item on your list if you are moving from smallest to largest debt. If you’re making payments on a car loan, that too will be one of your larger debts. Your secured debts are different in that they’re tied to your place of residence or your sole means of transportation. Losing your home can be extremely disruptive (and expensive), while the lack of a car could mean the inability to work. But if you simply can’t make those payments, you have a few options for relief.

Mortgage lenders and other creditors would most often rather work out a payment plan than add a house or car to their inventory, but you have to be proactive. The Federal Trade Commission (FTC) suggests the following actions for secured debt relief when you’re facing a financial emergency:

  • Request a deferment in payments for a specified number of months
  • Ask about having your monthly payments lowered, even if it’s for a limited amount of time (this will depend on your particular emergency)
  • Inquire about having your late fees waived or that lenders stop reporting your delinquencies to credit reporting companies while you work out an arrangement
  • Look into federal programs directed toward homeowners

Take Advantage of Available Government Programs

You may be eligible for certain government debt relief programs, depending on the type of debt and your particular emergency. If it’s a broader emergency affecting large portions of the population, the federal government may implement broad programs such as the extension of unemployment benefits following the 2008-2009 recession.

In response to the broad economic impacts of the 2020 COVID-19 pandemic, the U.S. Federal Reserve Bank cut interest rates to nearly 0 percent. On March 27, 2020 President Trump signed the CARES Act, a $2 trillion federal stimulus package. Benefits to Americans in this law include an increase and extension of unemployment benefits, small business loans, a cash payment to applicable individuals, and support for hard hit industries.

There are also some long-standing federal laws and programs that may help you in a time of financial stress:

  • Qualifying military service members called to active duty may seek debt relief through the Servicemembers Civil Relief Act (SCRA), including interest rate caps, protection against default judgments, and protection from evictions and non-judicial foreclosures
  • Hardship forbearance options may be available to those who are unable to make their monthly mortgage payments (Federal Housing Finance Agency and Federal Housing Administration)
  • You may be able to lower your federal tax obligation through an “offer in compromise” with the Internal Revenue Service
  • Bankruptcy protection is typically considered a last resort for struggling consumers and businesses but it may relieve you of your debt obligations if you lack other options

In addition, you may want to explore options at the state and local level.

Seeking professional help with your debt

Another option for getting a handle on your debts during a financial emergency is to consult with a professional. While it’s sometimes possible to work out deals with creditors and debt collectors, often, debt relief companies have more leverage and inside knowledge of the industry.

Debt relief organizations come in two main categories:

  1. Debt Management – You pay a credit counseling agency a single monthly fee, which it disburses among your creditors to pay off credit cards and other forms of unsecured debt
  2. Debt Settlement – You stop paying all of your credit card debt and put your money into a fund, which is used to negotiate with creditors

One big advantage of this type of service is that the company has the ability to do what are called bulk negotiations, where they combine multiple debts to a creditor together. This gives them greater leverage to negotiate a better settlement that reduces each consumer’s debt more than if they were each negotiated individually.

More options for tacking a financial emergency

Life is uncertain and no one is immune to emergencies, whether it comes in the form of a lost job, a death in the family, a natural disaster, or some other matter. If you’re struggling with debt, it might be time to take action. Freedom Debt Relief is here to help you understand your options for dealing with your debt, including our debt settlement program. Our Certified Debt Consultants can help you find a solution that will put you on the path to a better financial future. Find out if you qualify.