Key takeaways
- A recent survey from Lending Tree reports that 52% of Americans and 60% of young investors cannot cover a $1,000 emergency.
- With no emergency fund in place, many are tempted to take out payday loans, which charge predatory interest rates from 300% to 700%.
- If you haven’t built an emergency fund yet, you have three options: home equity line of credit, borrow against your 401(k), and credit cards.
- The absolute best solution is to establish an emergency fund that can cover at least a couple of months’ expenses. You can save into the fund over time to build it up. Then you’ll be prepared.
Years ago, I lived in Alaska and, one day, a soldier came up to me and said, “Sir, I need 50 for 100.” I asked, “What does that mean?” To which he replied, “You give me $50. In two days, I’ll pay you $100 back.” My response, “No! That’s highway robbery!” So, the soldier came back with, “Well, how about 50 for 200?” Obviously, he missed the point.
I don’t know what he needed that $50 for, but I was reminded of that conversation when I came across a recent survey conducted by Lending Tree. They surveyed 1,000 Americans and found that a full 52% of them could not cover a $1,000 emergency. In addition, 60% of young investors admitted they also couldn’t cover it. Clearly, it’s a problem.
What options do you have for covering an emergency other than entering into this 50 for 100 type of agreement? Obviously, some of the readily available ones aren’t that great. Lots of people go to these payday loan places where you pay 300% to 700% interest, depending on your particular state. It’s really horrible and even predatory.
How do you avoid this scenario? Build an emergency fund. Save into the fund until you have at least enough to cover expenses for a couple of months.
If you don’t yet have an emergency fund, I’d like to cover three other options for handling emergency situations (in preferential order):
- Home equity line of credit. If you have a mortgage on your home and what you owe is less than 80% of the property value, this becomes a real option. In this case, most lending institutions will allow you to take out a home equity line of credit that sits on top of your original mortgage loan. It typically has a checking account associated with it and you can write checks against it.
- Borrow against your 401(k). About 50% of 401(k)s have a provision in place for loans. You can take out a loan against your own retirement savings account. The neat thing about it is that you pay back interest into your own account. Again, I’m not an advocate of this, but if you run into a real emergency, it may be a place you can get help.
- Credit cards. Assuming you aren’t going to ask friends and family members for help, the last option is credit cards. While not a great choice, at least they charge much lower interest (typically 15% to 20%) than those payday loans.
The most important point is that it’s imperative to establish a dedicated emergency fund, so you don’t have to resort to these other options. That way, you won’t have to deal with any onerous interest rates from payday loans and credit cards, draw against your home equity, or get into your 401(k). Without preparing in advance, these emergencies could set you back for months or even years. Your emergency fund will make a huge difference in your life and you can grow your wealth more successfully over time. Until next time, enjoy.
Gary