Unexpected events that will cost you money occur on a regular basis. No one should ever even think about what IF something will happen, you must be prepared for WHEN IT DOES happen, because it’s only a matter of time, I guarantee it! As tight as your home budget may seem, you must put away some money for savings to cover expenses during a time of crisis. People know the concept of emergency preparedness and buy flashlights, duct tape and cans of food, but fewer people concentrate on saving money to prevent bankruptcy or avoid foreclosure in the event of a personal financial crisis. Common expenses that surprise people and tend to knock their whole financial world off course include major car repairs or replacement, medical problems, issues with children, legal problems, relationship trouble, job loss, misusing credit cards, home repair and the list goes on.
I like people to accrue a full six months of living expenses in savings. My experience as a former lawyer specializing in how to stop foreclosure tells me that a six month safety net would have saved the majority of people with mortgage trouble from unexpected short term life events. No one expects this rainy day fund to pop up overnight; it might take years to save enough. Having trouble saving in the first place? Get the bank to do it automatically for you. Many people spend what they have but won’t use it and won’t miss it if they never see it.
For those dedicated enough or lucky enough to accrue a safety savings fund your work continues by keeping it safe from potential pillagers, including you, so that it remains intact for a true personal financial emergency and not used before. Just in case it needs repeating, never keep disaster preparedness money in anything risky. I would even go so far as to advise not to invest those funds in stocks or bonds. You want to make sure that money is there when you need it; stock markets crash and investments go bad. You want the money liquid and out of danger. An FDIC insured bank stands as the best bet, if you go with a CD to get more interest make sure you can assess the money at any time without a penalty. For those who can’t stomach allowing money to sit uninvested get together 12 months of living expenses and invest it very conservatively. Don’t think by keeping the money in cash under your mattress you shield yourself from a bank failure, your risk of losing money through theft or fire exceeds the risk of simultaneous bank and FDIC collapse.
People sabotage their own safety funds in many ways. One simple rule must guide your relationship with your crisis preparedness account and needs to be both followed and understood. Use the money for emergencies only. When you want a big screen TV that would break your budget and you know more than enough sits in your disaster fund you will be tempted to plunder it. If you think you have a good use for the money examine if qualifies as a true crisis. While everyone comes to the table with unique situations you can look ask these questions of each instance:
Q. How long will this personal financial setback last?
A. When your plant shuts down for retooling and you get laid off for two months with a guarantee to be called back in a few months you know exactly when your financial problem looks to resolve itself. If you know you will gain the ability to re-accrue funds a decision to use just a small part of your savings might be acceptable. If you lose your job at a restaurant chances are some other job at some other eatery will open up, although you don’t know when. Some lose their high paying job at the only high paying employer in their city; in time they come to grips with the concept that their setback may be permanent. Medical problems often cause irreversible problems with personal finances as well.
Q. What further repercussions may occur from the emergency event?
A. Sometimes the nature of a problem means another issue lurks right on the horizon. Someone with a failed transmission needs to not only think about the repair costs but how it might affect their ability to get to work or do their job if they need their own vehicle on a daily basis. A disease can mean not only initial hospital bills but ongoing expensive drugs or treatments. When you lost your job as city’s largest employer closed, can it be just a matter of time until your spouse who works for their largest supplier gets laid off too?
Q. What other financial risks exist in your life unrelated to the present crisis?
A. As bad as things may seem, sometimes additional risks await to compound the situation attacking your personal finances. Is your child about to start college or an elderly parent about to move in? Perhaps your roof needs replacement soon or you have dental work that you must deal with. Maybe something directly related to money or the economy like the stock market dropping and you knowing you could face a large margin call. Depending on the specific event that caused your own personal finance disaster, some items might get mixed up between the last two categories, but that does not matter much, the main point remain preparing in advance for the money emergency.
Q. What do I specifically gain or protect with the disaster preparedness money?
A. Look at what you will actually do with the funds and make sure it’s something worthy of using your one time savings for and that you can protect things in the long run. Many people need a harsh reality check during this type of personal financial emergency and need to come to grips with the fact that losing a car or home might remain unavoidable. In some cases people waste all of their precious emergency savings on delaying the inevitable rather than protecting an asset they can save in the long run or having money to start a new financial life after the current crisis passes. In some cases you may want to find a bankruptcy lawyer and review your chapter 7 or chapter 13 questions to to make sure if you need to file bankruptcy you can exempt your emergency savings.
With these things in mind let’s go over an example based on a true case. An economic downturn ate away at a person’s sole proprietor business and he was getting behind on bills including the home mortgage. With the nation’s economy completely out of his control and his being unwilling or unable to get another job the timing for conclusion of the setback looked uncertain. Further repercussions of the recession meant the equity in the home was dropping and selling it might soon be lost as an option. The economy put one of the children’s jobs at risk and there existed a situation where they might need to move back home and force more expenses on the parents. The risk of foreclosure stood above other risks including lawsuits from credit card debt and unpaid suppliers.
None of this even starts to imagine the expenses and compounded trouble a divorce would have, and the relationship was rocky, debt damages many relationships. To start this person had no savings, but I convinced him he needed to start putting money aside. He might use the money to cure the mortgage, or to buy out the mortgage or to move, but in any event he needed to have cash ready. This case ended up taking about 18 months, the person promised to save about $500 per month and actually did it. Just before I called to say I negotiated a mortgage settlement on old mortgage that would save him $75,000 but I needed $5000 to complete the new mortgage refinance transaction he committed the ultimate sabotage on himself by spending all of the emergency preparedness money on his son’s wedding. “Isn’t it traditional that the bride’s family pays for the wedding?” I asked. “They couldn’t afford it.” He replied. Soon he lost both his house and his wife.
While that case demonstrated breaking every rule and unusual circumstances, every day I see people spend money on credit cards or a second mortgage rather than pay a first mortgage. You can read more in the section below or the who to pay when you can’t pay everyone article, but when using precious resources, especially emergency savings, think of what you want to use the money for and what else you might need it for soon. Ask yourself, for example, would you rather keep you credit cards or your house? Failure to understand the depth of a financial setback and deal with the larger picture causes improper use of emergency funds too. Take the person whose income gets cut in half and will never get back to the previous level. Often they use emergency funds to live, even if they just use safety money for the mortgage or important expenses they end up in foreclosure, because they just can’t afford their old lifestyle. Rather than dealing with the situation at the time and moving to a smaller cheaper house with their rainy day savings in tact they deplete it only to prolong the unavoidable.
With this new knowledge in mind, how does all of this come into play with credit card debt? Disaster savings money might be used for credit card debt under the following conditions:
1. The personal finance crisis has a known end time and will not reoccur.
2. You face no greater financial danger like mortgage trouble or not eating.
3. We will be able to replenish the special savings money when things get better.
4. You have good credit and the ability to maintain it long term.
For more information on this topic read the complete article specifically about using emergency preparedness money for credit card debt.