Every day, people face unexpected financial challenges that cause undue stress and lead to costly nightmares like bankruptcy, foreclosure, and overwhelming debt.
It's important to plan for the unexpected and keep some money in the bank at all times while working toward your financial goals.
Sometimes it's easy to convince yourself that you don't need an emergency fund because you can easily manage your regular bills and expenditures. But financial emergencies are inevitable.
Here are 6 financial emergencies and how to prepare for them.
Divorce is the last thing a couple considers when they tie the knot, but it is a shockingly real financial emergency for many married couples.
"Divorce is one of the most common financial emergencies that people face. The cost of hiring attorneys, dividing assets, and potentially changing your living situation can all add up quickly. The best way to prepare for a divorce is to get organized early on," said Antreas Koutis, Administrative Manager at Financer.
With the correct planning and a financial cushion, a divorce doesn't have to devastate you financially.
"Gather all the financial documents you can find, including tax returns, bank statements, and investment records. Make a list of your joint assets and debts and any income or expenses that are unique to you. Once you have a clear picture of your finances, you can start to develop a plan for how to best protect your interests in the event of a divorce," added Koutis.
Preparation is the key to making it through a divorce with as little financial damage as possible, which can be a relief given the emotional and financial toll it can take on you.
Aside from making preparations for divorce specifically, making preparations for any kind of unexpected financial emergency will safeguard your future financial situation after a divorce.
The main justification for having a savings account set aside for unforeseen events is that having your main source of income disappear is a true financial crisis.
"Way back when, at the start of the COVID-19 pandemic, I made a few radical changes within my business to help us weather the storm and, ideally, grow despite dire circumstances. My goal was to create a comfortable buffer of at least six months of cash flow. I hired a highly experienced CFO. I cut back on expenses. I found an alternative, cheaper digital tools," Matthew Stibbe, CEO of Articulate Marketing.
Being proactive is the best way to deal with cash flow problems. You can do several things to stop the drought from happening and help you save money for a rainy day.
"A combination of cutting back and investing in the right ways. You have to do both to survive. We grew 50% on the last year in 2022. That's huge. And if anything happens, I know I can pay my employees, pay my taxes and make calculated decisions, all because we have the cash in the bank," said Matthew.
"In the past couple of years, the most common financial emergency we have encountered among our clients is job loss," said Faris Khatib, CEO of IdealTax.
In 2022, American businesses experienced a massive influx of layoffs. While business expansion is slowing, labor costs are rising. As a result, businesses in many sectors across the United States have begun laying off employees in droves.
"Sadly, most people are ill-prepared, largely because finances are already tight, and people don't believe they have spare cash to put into an emergency fund," Faris added.
It can be difficult to make ends meet when you lose your job and primary source of income. However, you still have responsibilities such as housing costs (rent/mortgage), living expenses (utilities, food, etc.), and clothing. If this happens to you, relying on your emergency fund can help you get by while you look for a new job.
Start your emergency fund with a small goal first, say something like $300 and keep growing it until you can easily cover at least three months of living expenses. An emergency fund like this will ensure that a job loss will not force you to drown in debt.
Financial emergencies often arise due to unexpected medical or dental emergencies. Unexpected medical expenses can add up quickly, even if you have health insurance and pay a monthly premium. Having emergency savings is more important if you don't have health insurance.
"Illness has the double whammy of an abrupt rise in expenses and loss of income simultaneously. People with good health do not expect or anticipate that their health can fail, so mostly they are not prepared for a sudden bout of illness," said Beth Worthy, President at GMR Transcription.
"One should prepare for such a health emergency in two ways. The first is to buy good health insurance for oneself and one's family. The other would be to save enough money in liquid form to meet normal living expenses for at least six months in the face of a sudden drop in income. One should save a part of one's income for a rainy day irrespective of income," added Beth.
Having a health savings account (HSA) makes it easier to deal with medical costs when you least expect them. Even better, when you take money out of health savings accounts to pay for medical costs, you don't have to pay taxes.
A medical emergency can result in substantial unexpected expenses even with proper financial preparation. This may occur if, for example, your doctor bills for your visit to an out-of-network facility using an incorrect billing code or if you see a provider not in your insurance's network.
It's possible that you could have your bill reduced or corrected. This process has been made easier with the new No Surprises Act which protects patients from unexpected medical bills when they have no control over who is involved in their medical care.
No matter how good a driver you are or how dependable your vehicle is. You will eventually have to spend money on fixing, maintaining, and owning it. Unexpected expenses are also a part of owning and driving a car regularly. These expenses can add to your credit card debt if you don’t have the savings to pay for them.
"Car repairs rank among the most frequent financial emergencies that people encounter. Since a variety of emergencies might develop over time, it is challenging to factor repair expenditures into the budget," said Preston Powell, CEO of Webserv.
You'll get speeding tickets, parking tickets, and other fees, and your car will require unexpected maintenance and repairs. It will inevitably be scratched or dinged, and you may not want to go through insurance to have it repaired. In these situations, you will be forced to pay out of pocket.
"It's crucial to have both auto insurance and an emergency fund in case your insurance doesn't fully cover any car-related expenses," said Preston.
Though it will not help with existing damage to your car, performing routine maintenance on it will help keep it running smoothly for a longer period of time. It will also help you mitigate or avoid major damage to your vehicle in the future.
If your spouse were to pass away suddenly, you would also be deprived of their income. All your financial responsibilities, such as paying the mortgage, putting money away for the children's college education, or preparing for retirement, suddenly become a burden you are solely responsible for bearing.
There's also the matter of funeral and burial costs, which are exorbitant. Since the 1980s, the average funeral cost has been going up all the time. Today, it's not unusual for the average funeral to cost upto $9,000. Depending on the style and material, coffins and urns can cost thousands of dollars.
If your family members have life insurance, the death benefit payments could significantly reduce or eliminate these financial burdens. Similarly, if you are insured and have a Will, your untimely death will not result in a financial emergency for your loved ones.
To begin, make a monthly budget to track your spending habits. After compiling a detailed budget, you can start cutting off some luxuries to put more money towards an emergency fund.
Your emergency fund is best kept in a savings account instead of a checking account, where it can grow, and you won't be tempted to spend it.
You should keep your emergency fund relatively liquid so that you can access the money quickly for an unexpected expense.
It's important to review your budget regularly to make sure whether your emergency fund's target size needs to be adjusted.
People with less disposable income may need more time to build an emergency fund. Building an emergency fund requires consistent savings, even if only a tiny amount each month. An emergency fund should be able to cover at least six months worth of essential living expenses.
Even if you don't usually have an unplanned expense for years, you'll still feel better knowing you have a comfortable cushion in case you do.
There will always be unforeseen expenses in life. You might get sick, lose your job, or need expensive repairs for your vehicle or house due to a natural disaster. These can result in rising credit card balances, reduced retirement funds contributions, and stress. Financial stress can lead to poor mental health and affect your quality of life.
Now that you know the major financial emergencies to look out for, you can take the necessary steps to recover by purchasing insurance, increasing emergency savings, and making a plan.