Prepare for a Financial Emergency Using These 5 Simple Steps
While we all know the importance of preparing for a financial emergency, the truth is, most people are not prepared.
According to Bankrate’s Financial Security Index, “Just four in 10 U.S. adults (41 percent) would cover the cost of a $1,000 car repair or emergency room visit using savings.”¹
The issue is many financial emergencies cost more than $1,000. The same Bankrate survey reports, “Among respondents who reported that they or a close relative paid for a major unanticipated expense in the past year (28 percent), the average cost was $3,518.”²
Keep in mind that this is just referring to a common financial emergency, such as car repairs or emergency medical care.
But, as 2020 revealed, we never really know what financial emergency is around the corner.
Those who are unprepared tend to turn to credit cards, which only costs more in the long run.
Greg McBride, CFA, Bankrate chief financial analyst says, “This comes at a high cost, as the average $3,500 expense financed at the national average credit card rate of 17 percent would require monthly payments of $125, taking three years to pay off and incurring nearly $1,000 in finance charges. […] Whatever savings you can accumulate acts as a buffer from high-cost debt when unplanned expenses arise.”³
While we can’t always control when a financial emergency occurs, we can take steps to prepare.
Prepare for whatever comes your way with these 5 simple steps.
#1 Build an Emergency Fund
The key to preparing for a financial emergency is as simple as having an emergency fund.
The pandemic shifted most Americans’ thinking about saving.
According to Forbes, “As we emerge from the pandemic, many people want to be better prepared for the unknown. Forty-seven percent of people who didn’t have emergency savings before the pandemic said they plan to build their savings.”⁴
Generally, people are advised to save 3-6 months of expenses in case of a financial emergency. Also, experts advise that people should save 10-15% of their income.
So, if you’re currently putting 8% of your income in your 401(k), take the remaining 2-7% and fund your personal savings.
When working to build up your emergency fund, follow these simple steps:
- Set a goal. How much would you need should you get laid off, need to repair your roof, or have a medical emergency? What is 3-6 months’ worth of expenses for you? Figure out a number. Write it down.
- Make saving for emergencies a budget item. Treat your emergency fund as a line item on your budget. It must be paid each month.
- Automate savings. Eliminate the temptation to skip saving by automating your savings. Set up an automatic transfer from your checking account to your savings account.
- Pay yourself first. When you get paid, before you do anything else (pay bills, buy groceries, or buy anything), pay into your savings first. When a financial emergency happens, you’ll be glad you did.
#2 Make Smart Insurance Choices
Insurance is an essential element in protecting your finances and assets in the event of an emergency. And it keeps you from paying an arm and a leg for repairs or medical bills.
Even with insurance, it pays to make smart choices.
Bankrate reports, “According to 2021 insurance carrier data, the average annual premium for homeowners insurance is $1,312 (about $109 monthly), based on a policy with a dwelling coverage limit of $250,000.”⁵
Premiums vary widely depending on a number of conditions, such as where you live.
Don’t simply accept the first insurance premium you are offered. Shop around and find the right insurance for your needs.
Make sure you pay careful attention to your insurance’s limits and deductibles.
For instance, you want to choose insurance that will cover your potential costs in the event of a financial emergency.
Likewise, most coverages have deductibles, which you will be required to pay before coverage kicks in. Can you afford it?
#3 Find Ways to Build a Cushion for a Financial Emergency
Adding another line item to your budget may seem challenging, so look for additional ways to add a cushion.
Then, take every penny of the extra money you find or earn and put it toward building up your emergency fund.
- Sell your stuff. Take a look around your home and consider what items you could live without. Are their items just gathering dust and taking up space? Sell them! As the saying goes, “Your trash is someone else’s treasure.”
- Cut your budget. Go through your budget with a fine-tooth comb and find places where you can make cuts. For example, do you really need subscriptions to 4 streaming services? Do you need to spend that amount on gifts?
- Get a side hustle. During the pandemic, side hustles soared. People found unique ways to make extra money to cover their losses. Use the same idea to cushion your emergency fund. It doesn’t have to be forever; work your side hustle until you meet your savings goal.
#4 Boost Your Credit Score
If you face a financial emergency and you need more than you have in your emergency fund, you may need to borrow money.
In this case, you want to make sure you have a good credit score so, should you need to take out a personal loan or get a new credit card, you’ll get better interest rates (and pay less in the long run). Additionally, boosting your credit score also presents opportunities to refinance for a lower interest rate.
If your credit score isn’t what you’d like it to be, take steps now to improve it.
#5 Get out of Debt
According to Lending Tree’s Quarterly Report on Household Debt and Credit from the Federal Reserve Bank of New York, Americans now owe more than $1.2 trillion in auto loan debt — nearly double what it was just 10 years ago.⁶
And Experian reports the average credit card balance in the United States is now $5,315.⁷
No matter what kind of debt you are holding, it is keeping you from saving even more for emergencies, travel, and retirement. Each debt payment is one less payment toward yourself.
In addition, if you face a financial emergency and already have debt, it’s going to be even harder to get out of debt and make payments.
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