Are You Prepared for a Financial Emergency?
The first rule in being prepared for a financial emergency is not to use your emergency resources except for emergencies.
This may seem a lot like common sense but ignoring this first rule is what caught a lot of people flat-footed in the financial crisis. They had already maxed out their credit cards, drawn down their home equity line of credit, and borrowed against their retirement plan so that they had no reserves left when they lost their jobs or otherwise saw their incomes drop.
If you’ve already drawn on your reserves but so far have avoided any immediate emergency, the first order of business is to restore these safety nets—if you can—so they are there when you need them.
Aside from a general financial crisis like the recession of 2008-09, which is only slowly ending, there are a number of personal financial emergencies that can strike anyone at any time. Losing your job is one of the most obvious, as has been made painfully clear in the recession, especially for public sector employees as local authorities are rocked by budget cuts.
There are medical bills that can quickly exceed your healthcare coverage. Dental care in particular is widely uninsured and sometimes expensive treatment is not discretionary. There are accidents which can require medical attention or home care and which can also lead to loss of income. For those in or near retirement, a sudden drop in the stock market can diminish income unexpectedly. As you get older, you may find you unexpectedly need expensive nursing home care.
Here are some of the things you can do to prepare for these financial emergencies:
- Keep an emergency fund sufficient to cover anywhere from three to nine months of expenses. This should be a savings account or other readily accessible asset that you normally don’t touch. One recommendation that offers some flexibility is to keep six months’ expenses in the fund with the idea you can use up to three months of it for unexpected expenses that fall short of a genuine emergency.
- Various types of insurance are of course designed to help protect against financial emergencies. Health insurance, obviously, is obligatory given the high cost of care. Life insurance can support a family in the event of a breadwinner’s untimely death. If you have a big mortgage, mortgage life insurance that pays it off in the event of your death is an additional option. Homeowner’s insurance can guard against loss from fire or theft. Collision insurance for the car, which is generally optional even when liability insurance is required, protects against the loss of much-needed transportation or costly repairs. Disability insurance, which is offered by many companies but can also be purchased individually, guards against loss of income due to injury or illness. Do you need all these? The short answer is yes, especially if you have dependents who rely on your income. As expected life spans increase, long-term care insurance is becoming desirable to protect your spouse or children against the high costs of providing home or institutional care for you.
- Then there are the savings products designed for those major expenses that are not unexpected—such as tax-advantaged retirement funds or college savings plans. Most of these have some provision for either borrowing against or cashing out in the event of emergency, and this should be done only in the case of true emergencies. A Roth IRA is particularly flexible in this regard if you have the possibility of extra discretionary savings.
- A generally strong financial position also leaves you much better prepared for an emergency. Keeping credit card balances low not only saves money but gives you some ready financing for an unexpected crisis. Establishing a Heloc, but not using it, is also a useful tool—particularly for emergency home expenses like a new furnace or air-conditioning unit. In general, growing the equity in your home as quickly as possible creates another buffer in an emergency.
- Open a checking account at a credit union or community bank, where you are likelier to be seen as a person rather than just as a credit rating and can get approval for a personal line of credit that you can tap in an emergency. With the increased caps on federal deposit insurance, this generally incurs no risk.
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