Even among high-earners, Americans are woefully underprepared for dealing with an unexpected financial emergency—in other words, a financial shock. Nearly half of middle-class earners would have a hard time generating even $400 to directly cover a sudden expense.
Financial emergencies are devastating to the underprepared, for several reasons. For starters, it disrupts their budget, and usually demands both time and money for immediate response. On top of that, incurring debt usually comes with high interest rates, which can put a family even further in debt and add stress to monthly payments.
So if you’re underprepared for a financial emergency, what’s the best way to handle it, and recover without compromising your financial future?
Types of Financial Emergencies
First, let’s examine some of the most common types of financial emergencies:
- Job loss or change. Most household budgets revolve around that household’s primary line of income. If you experience a sudden change in your job, such as a drop in salary, a displacement, or the entire loss of your full-time salary, you’ll be hard-pressed to make that initial budget work. Your ordinary expenses will start to accumulate, costing you thousands of dollars a month with no income to offset them.
- Medical needs. If you or a family member gets injured or ill, you may face a line of expensive medical bills—even if you have an insurance plan. Chronic and sudden illnesses alike can get expensive fast, and unexpected accidents can cause injuries without warning. It’s no surprise that medical expenses are the leading cause of bankruptcy.
- Moves and travel. Moving and travel can both be expensive as well, and you may be required to move without much warning. For example, your job may require you to move to another city, or you may need to move back to your hometown to take care of an ailing parent. This can cost thousands of dollars.
- You may also face an emergency if your home or vehicle needs serious maintenance or repairs. If your roof is leaking, or if your car won’t start, you can’t afford to wait for more stable financial times—you need to act immediately.
Coping With an Emergency
Let’s say you’ve experienced one. What should you do now?
- Initial reaction and management. First, you need to stop the bleeding. Waiting to get medical attention when you’re injured can make your injury worse, or even threaten your life. Waiting to fix a leaking roof can result in even more damage. Focus on taking care of the bare minimum necessary to preserve your health, ability to work, and basic necessities, and use your current emergency savings if you have some.
- External resources and compensation. Next, look to external and alternative means of compensation and help. For example, you might find a discount offer from a competing business, or if you’re injured in an accident, you may be able to take legal action to compensate you for the damages.
- Understanding payment options. From there, you may need to do some research on your payment options. If you owe more than your emergency budget will allow, you’ll either need to set up a payment plan with the person or organization you owe, or accumulate debt. Allowing the interest rates on that debt to compound can put you even further behind, so make a firm plan on how you’re going to pay off that debt as soon as possible. Plan on making more than the minimum payments each month, and try to forecast how soon you can eliminate your debt if you funnel all your resources to it.
- Readjusting your budget. Finally, adjust your budget to accommodate your new financial landscape. Oftentimes, that means cutting out luxury expenses you’ve gotten used to, or downsizing your home and lifestyle. It may also mean picking up an extra job to supplement your income. It’s not fun, but it will help you pull yourself out of debt, conquer this financial emergency, and start preparing for future shocks down the road.
Preparing for Another Shock
Getting over your initial shock is a big and important step forward, but there will likely be more financial emergencies on the horizon. It’s estimated that the median cost of households’ most expensive shocks is $2,000, and if you’re not prepared for that, you could end up in an even worse position.
Once you’ve recovered from an initial financial emergency, one of your top priorities should be preparing for the next one. Set aside a little money every month to build up an emergency fund of at least $2,000, and preferably one to cover 6 months of living expenses. It may be difficult to manage, but it’s important if you want to build your tolerance for financial shocks.