Saving for unexpected expenses
The problem with unexpected expenses is that we don’t expect them… or more accurately we expect them to happen to other people, just not us. Whether that is something as small as needing to replace some washers on the kitchen tap, the fridge that we’ve had for years finally packs it in, or fork out cash to cover the excess on a car insurance claim – the issue remains the same, if you don’t expect it to happen to you, you tend to not think you need to set money aside.. because you know, it won’t happen to us.
This is where we tell our clients to ‘plan for the worst and hope for the best’ or more accurately when it comes to unexpected expenses, we want them to assume it might happen to them and build an emergency fund just in case – then hope they never need to use it.
What types of unexpected expenses could you find yourself needing to cover?
There is no point preparing for something that doesn’t apply to you, or if you lost it – you simply wouldn’t need to replace it. So, you should only be looking at the types of ‘realistic unexpected expenses’ that could apply to you. Then ask yourself “what would happen if?” The car broke down, A big appliance broke in the house, or at the other end of the severity scale – if I got injured, sick or lost my job?
If the answer to the question is “I’d go without or I’d just wait until I saved up enough to replace / fix the lost item” then you obviously don’t need to do much about it. But if the answer is “I’m not sure what I’d do because it would cost more than I have available” then it’s time to start building your unexpected expenses aka Emergency Fund.
So how much should I have in my Emergency Fund?
An Emergency Fund is just what it sounds like – a ‘fund’ (usually a Bank Account) that can be accessed quickly and at no or very low cost, that has enough money in it to cover the majority of Emergencies that are likely to happen to you.
At the absolute minimum you’d have a couple of hundred dollars in there, and at the maximum you could be looking at anything up to 6 months or even 2 years of your income (in case you aren’t eligible for insurances like Income Protection – of if you don’t have these insurances in place).
With our clients we tend to recommend somewhere between 2 and 3 months’ worth of take home income (based on the highest income earner). This is because the ‘unexpected expense’ that we believe needs to be prepared for – in case of emergency – is if they were off work due to injury or illness and they needed to replace their income during this time.
The added benefit of having 2 to 3 months income stored up in an Emergency Fund is that it could also be used in the case of other less financially destructive scenarios, like excess payments on car or home insurances, or to replace lost or damaged items.
Typically, most Aussies either haven’t built up an Emergency Fund yet so they need to look at other options, if using their own savings isn’t an option.
What to do if you don’t have cash available?
Depending on your current situation will depend on what options are available.
Redrawing from Loans
If you’ve been able to make additional repayments into a Variable Rate loan, you may be able to ‘redraw’ back some of these funds. The general rule of thumb is you can get out whatever extra you’ve put in, less the amount of your next repayment. Word of caution is you may not be able to access these additional repayments in fixed loans, and redrawing on your loan may also change your minimum repayment.
Credit Cards are the most commonly used short term emergency option. This can sometimes be one the worst options because if you don’t have the ability to pay off the full Credit Card closing balance on the due date, you’ll pay interest on the full amount of the emergency expense (plus other purchases made on the card) from day 1. Interest rates on credit cards are usually greater than 20% which means you could be looking at a very large interest bill.
“Interest Free” Cards
Another option is to make the replacement purchase using an ‘interest free’ option that most of the big retailers provide these days. These options are still effectively credit cards even though to provide a period of ‘interest free’. The trap here is the minimum repayment often isn’t enough to clear the balance over the term of the repayment period, and at the end you’ll be hit with interest at rate of as high as 29%. The way these interest free cards really make money, is by convincing you to use the card again to make another purchase but using a different repayment plan… the switch between “With Monthly Payments” and “With No Payments” options. Any repayments you make are almost always counted towards your “With Monthly Payments” purchase first. This means even if you have a larger amount of money owing on the “With No Payments” options your payments have to count towards the other repayment type. This is where the trap is… because the stores want you to get to the end of the longer, larger interest free period with a large balance to repay (typically these are the bigger purchases because they are the ones with longer interest free periods – sometimes up to 60 months) – because interest payments on these amounts can be as high as 29%.
Buy now, Pay Later (after pay, zipPay)
These services advertise access to quick and painless access to purchases with repayments broken out into a number of instalments over a shorter time-frame. The pitfalls of these services are late fees for missing your scheduled repayments, payment processing fees and potentially monthly account keeping fees.
For people on low income, the No Interest Loans Scheme provides them with a transparent, safe, fair and affordable loan service up to $1,500.00 for essential goods and services such as fridges, washing machines or medical procedures. Repayments are set out over 12-18 months, but these options are much harder to access due to strict eligibility criteria.
What’s the best option for you if you don’t have an Emergency Fund?
The key to using any sort of borrowed money (which effectively all these options are) is to truly understand what you are signing up for, the terms and conditions are usually written in a way that they are so confusing, most of us just sign up and move on without really knowing what we’re signing up for. Once you’ve understood what you’re signing up for the most important part is to actually set yourself a plan on how you are going to pay it off, as fast as possible giving you the best chance of not paying any interest or keeping it to an absolute minimum.
If you feel like you need help, please go seek some advice from a Financial Adviser or Credit Representative, this is just to be used as a guide only. Knowledge is power.