Handling (And Mishandling) Unexpected Expenses

Handling (And Mishandling) Unexpected Expenses

Handling (And Mishandling) Unexpected Expenses
Reading Time: 6 mins

If you’ve never thought about setting up an emergency fund, you’re not alone. Most Canadians don’t have a plan to deal with unexpected expenses. This means that all it takes is a minor emergency to make them financially insecure. The smallest of expenses, when unexpected, can derail the financial stability of most Canadians. If this is the case, then why aren’t more people thinking about unexpected expenses and the need to save for them?

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First, it scares people to think about emergencies, so it’s common to operate with the assumption that they only happen to other people. Secondly, most people have a skewed sense of what constitutes an emergency. They associate an emergency with something unlikely to happen, like an accident or a medical procedure. While those things are emergencies, unexpected expenses also include other things that are likely to happen to anyone.

Dropped your phone and shattered its screen? If you don’t have insurance for your phone, there’s an unexpected expense for you. It doesn’t even have to be an accident. Maybe your phone starts malfunctioning due to extreme workload and you suddenly need a new one. That’s certainly a major expense that you wouldn’t have planned for.

What about car repairs? Those always come up when you least expect it. Or how about extra-curricular expenses for your kids or needing to buy gifts for family events like anniversaries? Or maybe you’ll finally be forced to take care of that leaking roof in your house.

All these are unexpected expenses for which you’ll have to plan if you want to be able to handle them when they arise.

How To Deal With Unexpected Expenses

The first thing you should understand is that while expenses may be unexpected, these types of events are not rare. If and when they happen, there are a number of options available to you.

Emergency Savings

Even if you’re healthy, have a steady income, and don’t have any major loan or mortgage payments, you still need to build an emergency fund. Set aside a part of your income for this fund and let contributing to it be one of the first things you do when you get your paycheck. You could even automate the process to make it that much simpler.

Building an emergency fund helps ensure that when you have unexpected expenses, you won’t need to seek outside help, you can just take it from your emergency fund. But make sure that you renew those savings once you handle the emergency. If you can, you should attempt to compensate for your withdrawal by saving a bit more than you usually would out of your next few paychecks. Simply set aside a slightly larger portion for your emergency fund and it will refill in no time.

Get Help From Family Or Friends

It might sound embarrassing to ask friends or family for help, but remember that you won’t have to pay any interest on this kind of loan. However, there are a couple of things you should keep in mind if you do end up asking your family or friends for funds.

First of all, describe the emergency and explain why you need help. Once they know the situation, people will be more willing to help. Transparency will speed up the process.

Secondly, understand that one individual may not be able to offer you the total amount you need—they may only be able to give half or a portion of it. This means you may have to reach out to a few people to get the full amount required. Again, transparency is key here. Make sure you be clear about who you’ve already asked for funds and what amounts they have provided. This makes your request more credible and ensures you aren’t keeping anyone in the dark.

The third thing to keep in mind is that even though you might feel rushed to get the money as fast as possible, you should always make a point to share a plan and timeframe for repaying the loan. Try to be specific. Instead of saying you’ll pay them back “in a few months,” set a date for the payment or the first installment. That will reassure people of your ability and willingness to pay back the personal loan.

At MoneyWizard, one thing we always tell people is that all financial transactions should be documented. So make sure to either text or email anyone who provides you with a loan with your repayment plan. This will keep everyone on the same page and make it easy for them to trust you.

Line Of Credit

A third option is to seek a line of credit. If you can get credit at a low rate of interest, you won’t have to withdraw from your emergency fund. Keep in mind that to easily access lines of credit at low rates, you’ll need to have a good credit score and a long relationship with a given financial provider.

This is why it’s important to keep your monthly expenses within your budget and always pay your credit card bills on time (please link to that article about credit card payments). Even if you can only make the minimum payment, make sure you pay it every month and slowly increase your payment over time.

The second aspect is your relationship with your bank. It’s always an excellent idea not to change financial provider unless there’s a compelling reason. The longer you have an account with a financial institution (along with a good credit score) the more willing they will be to extend you a line of credit.

But this can also be an opportunity to seek out better offers. Just because you get an offer on a line of credit from your current bank doesn’t mean that you have to accept it. Feel free to reach out to other banks who might use this as an opportunity to sell you other products in the future.

In other words, just because it’s an unexpected expense doesn’t mean you have to decide how to cover it as quickly as possible. Ask around, check websites, or send email inquiries. You never know who might try and entice you with an “introductory offer.”

Dip Into Your Retirement Funds

Only consider disturbing your retirement funds as a last resort if you aren’t able to get the money you need through any other avenue or if it’s a major emergency that cannot be handled by other funds.

That’s because if you withdraw from your 401(k) or IRA accounts, you’ll be taxed at your regular income tax rates. So calculate the amount you want for your unexpected expenses, determine the tax you’ll have to pay on that amount, and then decide if it’s the right option.

How Not To Deal With Unexpected Expenses

While we’ve listed some of the right ways to deal with emergency expenses, there are also certain don’ts. The big problem is that these options are heavily advertised and very convenient, which makes them seem attractive even though they do more harm than good in the long run.

Payday Loans

A better name for a payday loan would be “endless cycles of debt,” because once you take a payday loan, that’s exactly what you’ll be entering. To begin with, the interest rates can be obscenely high. Calculated annually, these could reach as high as 400 percent.

Secondly, you won’t have a comfortable enough period to repay the loan. This ensures that you’ll miss the payments, which will further increase your balance. Ultimately, this cycle will damage your credit and if you fail to repay, you could even end up in court.

Unfortunately, people often opt for payday loans because they’re easy to get and widely advertised. This makes them top-of-mind and then when an emergency strikes, it often comes up as the first option. But, by all means, resist the temptation.

Cash Advances

This is another option that’s convenient and fast but should always be avoided. Cash advances from credit cards come with steep interest rates. Plus, there could be additional fees. Also keep in mind that the interest rate is applied from the moment you withdraw the cash, this means that there are no grace periods for cash advances.

Given the high interest rates, you’ll have to eventually reach into your savings. If you don’t make the payments on time, you will also face additional fees.

Importantly, this has the potential to affect your overall credit score. That’s because the amount you withdraw using your credit card will increase the percentage of available credit you’re using, which will negatively affect your credit score.

Max Out Your Credit Cards

Here’s the thing about credit card limits: usually you won’t know you’ve hit your limit until the person you’ve handed your card to informs you that the funds are insufficient, at which point you won’t be able to do anything. So when you plan on using your credit card for unexpected expenses, you may not know whether that will be enough.

Secondly, maxing out your credit card will increase your monthly payment, making it difficult to repay. Once you miss a payment, your credit score is also likely to be affected.

Prepare For The Unexpected

There will always be unexpected expenses, no matter how careful or healthy you are. The only way to ensure you don’t take a massive financial hit is by building a robust emergency fund. This will help you manage unexpected expenses without ruining your credit score.

The way to do this is by starting early. Set aside a portion of your income every month. As your income increases, so should your monthly savings for your emergency funds. What’s important is to be consistent about it. Secondly, cut down on frivolous and impulsive expenses. That alone will be a huge step toward safeguarding your financial health.

Conclusion

An emergency fund is not something most Canadians want to discuss, but building one is crucial for handling unexpected expenses when they crop up. The difference between those who weather the storm and those who don’t isn’t luck alone, it’s preparation.

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