Don’t Panic: How to Handle a Financial Emergency

Source: Thinkstock

Source: Thinkstock

While we all hope to avoid financial emergencies, or, at least, have as few as possible, sometimes the inevitable happens. Life is unexpected, and even people who carefully manage their finances sometimes face financial emergencies. There are many different kinds of financial emergencies, and what constitutes an emergency for you might not be an emergency for someone else. Suddenly needing to purchase a new fridge can set some people back significantly, while others might be more financially impacted when bigger home expenses arise, such as needing a new air conditioner or siding. While the amount that constitutes an emergency differs from person to person, the affect is the same: financial emergencies are stressful. Depending on your unique situation, you may already have the money necessary to fix the problem, or you might need to borrow it. Facing a financial emergency is scary and can be overwhelming, but there are ways to handle the situation.

There are many different financial emergencies you might face. Hopefully you will see that your air conditioner or furnace isn’t running as well, and be able to predict home repairs ahead of time. However, this doesn’t always happen: sometimes things just break. Home repairs can be costly. Car repairs can be costly as well, whether they are related to wear and tear, or an accident. Medical emergencies are often the most expensive, because you have to factor in your deductible, and maximum out-of-pocket, and for many people, those amounts are really high. There are also potential emergencies like losing a job, being unable to work for medical reasons, and of course there’s the less likely chance that a fire or other disaster could occur.

The types of financial emergencies are endless. Some are more common, like home repairs, but it is good to prepare for bigger problems as well. You should always have home or renter’s insurance, but you can also protect yourself by getting insurance for your appliances, cars, etc. The main question is how much the items are worth to you. If you have a dishwasher that is already ten years old, it might not be worth insuring.

Often the best way to prepare ahead of time for a financial emergency is to have an emergency fund. Even if you can’t save enough to pay for any and all emergencies, you will at least have some money set aside when you need to pay for something quickly. You should have at least six months of net income saved in an emergency fund, but the more the better, especially if your job is unstable.

If you face an emergency, and you have a rainy day fund, then you should first look to that. Although taking a big chunk out of your emergency fund will hurt, that is really what the emergency fund is for. If you can use your emergency fund and avoid borrowing money or using a credit card, you should. Hopefully you can build your fund back up once the emergency is over.

On the other hand, if you are currently facing a financial emergency, or one happens before you can build your emergency fund, then you might need to borrow money. Your best bet is to secure an interest-free loan, which might require talking to your parents or a family member. Although this can be difficult, and isn’t ideal in all situations, you are better off asking a family member for help in an emergency than regularly mooching from them or expecting them to pay for things: most family members will understand a genuine emergency and want to help. Just make sure you pay them back quickly, and if you are concerned (or they are) about the legalities, get help from a professional and get everything in writing. If you can’t borrow from someone interest-free, you might need to take out a loan, but be sure to proceed carefully: some loans require a significant interest rate or require a convenience charge.

Depending on the cost of your emergency, you may be able to fix the problem and work out a payment plan. Many appliance companies, as well as many medical offices, will work out payment plans. If you are able to negotiate one that works for you, make your next priority reducing your expenses. Look over your budget, and cut out any items that you don’t need so you can pay back the amount of the purchase (or fix) as quickly as possible. You can also consider selling items that you don’t need if possible.

If you can’t make room in your budget, you don’t have an emergency fund, and you can’t borrow the money from a family member or secure a different loan, you might wonder about borrowing from your 401k. This is a controversial step, but it can be done if your plan allows it. If you are withdrawing money based on a financial hardship, you will need to prove that you really do need the money. The four IRS-approved reasons include: college tuition, a down payment on a primary residence, certain medical expenses, and the prevention of foreclosure or eviction. You might be able to take a loan as well, but you will have to pay it back later.

When you take money out of your 401k, you won’t be able to earn anything from that money, which affects your total 401k, and you may also miss out on certain benefits. You should try to avoid taking money out of your 401k if you can, but the truth is that sometimes emergencies happen, and if you have explored every other option, you might need to use some of your 401k. Emergencies happen, so if possible, try to save ahead of time so that you don’t need to use your 401k or take out a high-interest loan.

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