Here’s something that everyone should know: no matter how careful, prudent, or healthy you are, you will face unexpected expenses. These expenses could be in the form of car repairs, medical bills, expenses for a family member, etc. While you can’t predict when unexpected expenses might occur, there’s a lot you can do to manage them.
Ironically, many people believe unexpected expenses are what stand in the way of their financial security. They think these expenses destroy their savings and stop them from building a nest egg. In fact, the fear of unexpected expenses is often what discourages people from making a serious commitment to their personal financial management.
Breaking Down Unexpected Expenses
From our conversations with personal finance experts, we at MoneyWizard have learned something peculiar about emergencies: They may not be emergencies in the conventional sense. We’re not talking about just health crises or accidents. There are other normal expenses which can be counted as unexpected due to their timing.
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For example, if you’re a renter, you might have to move out of your current residence unexpectedly if your home needs serious repair or is sold by the owner. Because you could not foresee this expense, it would count as unexpected, even though it’s not technically an emergency.
Or what if your refrigerator breaks or your child wants to enroll in an expensive program at school? It’s not a question of “if” you’ll have to incur these expenses, the only question is “when.” And when they do come, there’s little you can do to postpone them.
So, unexpected expenses really should be called sudden and unavoidable expenses.
How To Deal With Unexpected Expenses
It’s important to take unexpected expenses into account because they don’t just cause financial problems, they can also make you feel anxious, defeated, and cynical about saving money. That’s why you have to take a proactive method to handle these emergencies.
Unfortunately, most people’s budgets only go so far as to handle their monthly income, expenses, and savings. By including the possibility of emergency expenses in your overall financial planning, you can be better prepared and help ensure that you are not financially worse off in the face of unanticipated expenses. To help you out, here are three ways in which you can take care of those unexpected expenses.
The first option is to use your emergency savings. Of course, this means you need to have emergency savings. This is the number one reason why you should be diligent about parking a part of your income in savings. Not just that, you should be progressively increasing the proportion of your income you save each month.
Also, make sure that any unexpected income you get goes directly into your savings. This might be a bonus or a commission that you receive from work. Since you never know the scale of an unexpected expense, it’s good to err on the side of caution.
This is necessary because it’s always possible that you’ll encounter more than one unexpected expense at a time. For example, you might need car repairs in the same month that you have to buy a gift for your boss’ anniversary party. Unless you set aside a portion of your income and consistently grow it, you might be unprepared to manage these emergencies as they come up.
Line Of Credit
If you’d rather not break into your emergency savings to cover an expense, another option is to opt for a line of credit. However, if you choose to do this, make sure that you get it at an affordable rate of interest.
There are a few additional things to keep in mind if you plan to take a line of credit. First, it would be easier to avail of a loan from a financial service provider that you already have a relationship with. The bank where you have your checking/savings account would be a good first option for quick credit. In most cases, you’ll be able to apply for this digitally without having to visit them in person.
The second thing to understand is that for a bank or any financial service provider to offer you credit, they have to be confident about your ability to repay. This is why it is important to maintain good credit and a clean financial history with banks. If you ensure that you never default on your credit card payments and always maintain a healthy monthly average, your bank will be much more interested in offering additional financial products to you.
Thirdly, the longer your relationship with a bank, the easier it will be for you to get a line of credit at an affordable rate of interest, so don’t change banks too often.
A third option is to ask someone to lend you money. This could be a family member, friend, or colleague. Most people are embarrassed to ask their immediate family or friends for help, but remember that a loan from them won’t have the burden of interest and, in most cases, other people understand the need for cash in the face of an emergency expense.
If you’re lucky enough to have someone lend you money, make sure you set a clear timeline for repayment. Whether you do it in one go or over several instalments, take them into your confidence by sharing your plan with them. Importantly, start repaying as soon as possible, even if it’s a small percentage every month.
That way, it will be much easier to approach them for any unexpected expenses that might occur in the future.
Dip into Your TFSA or RRSP
There’s always the option to withdraw money from your TFSA or RRSP. Between the two, TFSA is a better option, because if you dip into your RRSP, you may have to incur some expenses.
To begin with, you may have to pay a withdrawal fee of around $50. Most people are unaware of this until they need to make an emergency withdrawal. Secondly, your opportunity to contribute vanishes if you take money from your RRSP. But with TFSA, you’ll be able to re-contribute even after a withdrawal.
Thirdly, there will be tax implications. You may have to pay income and withholding taxes on your withdrawal.
How Not To Deal With Unexpected Expenses
You should never take out a payday loan, as they’re notoriously difficult to repay. They come with exceptionally high interest rates and fees. In some instances, the interest rates and other fees can be as much as 400% of the original loan amount. That’s why even some governments discourage their use.
By Canadian law, a payday loan can never exceed $1500. It’s not just the total amount that has restrictions, there are limits on the repayment period too. For example, in Ontario, the period cannot exceed 62 days.
At first glance, taking a cash advance—withdrawing cash from your credit card via an ATM or a financial institution—seems like a convenient and fast option. After all, there’s no need to fill out any online forms or submit a request in person. But credit card cash advances should be avoided for several reasons.
First of all, you’ll have to pay an extremely high interest rate on the cash that you borrow. This is irrespective of your financial history or credit card usage. Secondly, the interest rates kick in from the moment you withdraw the cash.
Thirdly, there’s an unavoidable advance fee that credit card companies charge you for cash withdrawals. Finally, cash withdrawals don’t come with grace periods. This is crucial, as any inability to repay will further push up your interest rate, invite additional fees, and damage your credit history.
Max Out Your Credit Cards
Like cash withdrawals, pushing your credit card to its limit is also a seemingly convenient option, but it will quickly put you on a financial slippery slope. If you hit your credit card’s limit, one of the first things that happens is your monthly minimum payments will immediately increase, which will make it difficult to manage your budget.
Also, your credit score will take a hit, which will make it harder to get funds from financial institutions.
Prepare For The Unexpected
So how do you financially prepare for these unexpected and unavoidable expenses? By building a sizeable emergency fund.
But how big should your emergency savings be? Most of the experts MoneyWizard talked to suggest that your emergency funds should be able to cover your monthly expenses for anywhere from three to six months.
You should also cut down on impulse purchases and unnecessary expenses. Do you have to eat out twice a week? Do you need all those subscriptions? What about that health club membership? Importantly, whatever you save should go into your emergency savings fund.
Life being what it is, there will always be unexpected expenses. But a clear plan will help you withstand the effects of these expenses and rebound faster. The key to that is building an emergency savings fund, maintaining a good credit history, and minimizing wasteful expenses. This will help ensure that you’ll be able to weather the storm and get on with your life without much trouble.