What is a Financial Emergency and How to Deal With One

Life is full of surprises. Some of those surprises are good news, like someone buying you that gift you've been eyeing for months. Other surprises can be stressful, especially when they come with unplanned costs. We call these surprises financial emergencies, and sometimes they lead to a need for debt relief.

The good news is there are ways to get your finances back on track after an emergency. The key is to figure out which option is the most cost-effective for you.

Common Financial Emergencies

Financial emergencies break down into two categories: a loss of income and unexpected expenses. Below we’ll cover some common examples. Then we’ll go into strategies for handling them.

• Job loss: Losing your job, or even having your hours cut, can have a significant effect on how much money your household brings in.

• Death of a breadwinner: Losing a breadwinner's income often brings major shifts to your household finances.

• Medical debt: This may include things like ER visits as well as planned medical care.

• Auto repairs: While auto insurance covers collisions, routine maintenance is usually up to the vehicle owner.

• Home repairs: Your home and appliances may also need maintenance or upgrading from time to time.

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Strategies for Coping with a Financial Emergency

Here are some steps you could take to get control of a financial emergency. 

Take a breath

Take some time to assess the situation calmly. People just like you cope with financial emergencies all the time. You can do it, too. If it's a larger issue that affects more than your finances, like a tree smashing through the roof of your home, make a list of things you need to do to resolve the situation, and prioritize the tasks. Then check them off one by one.

Check your insurance when appropriate

Your home or auto insurance policy may help you cover some of your financial emergency costs. Give your policy a quick read, or reach out to your insurance agent if you're not sure what's covered.

You may have more coverage than you think. For example, many auto insurance policies have coverage for rental vehicles, too. Your homeowners insurance policy may also cover some lost or stolen items, even if the loss or theft occurred away from home. However, with all insurance claims, you must weigh the potential cash you could receive against a possible rise in premiums to decide if this is your best option.

Draw upon your emergency fund if you have one

An emergency fund is money you keep in a bank account specifically to help you cover financial emergencies. Ideally, you'd save three to six months of living expenses here. But anything is better than nothing.

If you don't have an emergency fund, consider building one. It's okay to start small. Even if you save just $10 per week, you'd have over $500 in a year. That's enough to cover many small emergencies. 

Negotiate your bills

If you're struggling with some payments due to a financial emergency, try contacting the creditor about your situation. Some companies will give you additional time to pay, or help you set up a payment plan so you don't incur late fees.

If you're already behind on your payments, you may want to consider a more permanent solution, like debt settlement. This is when you negotiate with your creditors, asking them to accept a smaller sum than what you actually owe. You can do this on your own or with the help of a debt settlement company.

Consider a personal loan

Personal loans are loans you can use for just about any purpose. You could cover an immediate cost, pay down debt, or finance a large purchase. These loans usually have fixed monthly payments over a number of years.

Personal loans usually don't require collateral. Collateral is something the creditor could take from you if you default on the loan. Interest rates for personal loans are typically lower than credit card rates but higher than home equity loan rates. 

Some lenders charge a fee for personal loans.

Consider a home equity loan

A home equity loan could be an option if you’re a homeowner with sufficient equity. Equity is the difference between your home’s value and your mortgage balance. Each lender sets its own rules for how much equity you must have, and how much you can borrow.

Applying for a home equity loan is simpler than applying for a mortgage. You need to provide information about your home, your income, and your existing debts. 

Most home equity lenders charge a fee for making the loan. 

Pay with your credit card

Generally, you want to only charge items to your credit card that you know you can pay back at the end of the month. But that credit limit can be useful in a pinch when you have nowhere else to turn. If you do this, only charge what you have to, and work to pay it off as quickly as possible.

If you have a credit card with a 0% introductory annual percentage rate (APR), consider paying for the financial emergency with this card. Then you won't have to worry about your balance accruing interest until the end of the 0% APR period. If you have cash-back credit card rewards, you can also redeem points for a statement credit, which reduces your outstanding balance, helping you pay down your debt even faster.

Tap your 401(k)

If you have a 401(k) and you're experiencing a financial emergency, you may qualify for a hardship withdrawal. This lets you take out money to satisfy an immediate financial need, regardless of your age at the time.

Keep in mind that you will owe taxes on hardship withdrawals unless the money comes from a Roth 401(k). You could also owe a 10% early withdrawal penalty if you're under 59 and a half at the time. For these reasons, and the fact that early withdrawals slow the growth of your retirement savings, consider this an option of last resort.

See if you qualify for government assistance

The federal government has programs to help people struggling financially cover basic expenses, including:

• Housing

• Food

• Utilities

• Healthcare

Your state or local government may also provide assistance programs. Charitable organizations like Catholic Charities, Jewish Family Services, the Salvation Army, and other organizations operating in your area are worth looking into. 

Weigh the Pros and Cons of Your Options in a Financial Emergency

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

As you go through your options, avoid the ones that are so expensive they would worsen the problem. For example, payday loans are so costly that most people have a hard time paying them back. 

When you've recovered from your financial emergency, replenish your emergency fund. This helps you get ready for the next time an unexpected expense comes your way.