January 2006
If it isn't enough
Emergencies are unpredictable almost by definition. And while having a reasonable amount of money in an emergency fund is
a prudent measure, it's possible that a crisis may come along that is too costly for the money you've set aside. In many cases
it isn't just one high-ticket expense but several blows in a row—uninsured medical expenses, a lawsuit, a car crash, a divorce—that
deplete people's assets. So where should you plan to turn for money in a situation like that? Here are a half-dozen options,
loosely ranked from most to least attractive in terms of their costs and risks:
- Sell some stuff. We weren't even going to include this one, thinking it was too obvious. But it came up on all our planners' lists, often
at the very top.
Pros: Not only will you clear cash, but you may even clean out the garage for the first time since Jerry Ford was president.
Cons: "This one is all pro and no con," says Mary Lacey Gibson, a certified financial planner in San Juan Bautista, Calif. "In many ways it gets a client focused on what's important in her life." Indeed, some assets, say, a gas-chugging third car or heavily-insured antique tiara, are in reality cash-drainers.
How to do it: Try eBay, hold your own yard sale, or put an ad in the paper. - Hit up the kinfolk. If you have relatives who can bail you out, that may be one of the first places you'll want to turn. Same if you have friends
who are so close that you'd be comfortable asking for a loan.
Pros: Your family or friends are likely to want to help and may be able to move more quickly than, for example, a bank.
Cons: Mess up and you may never be invited to Thanksgiving dinner again.
How to do it: "It needs to be clearly stated, in writing, if it is a gift or a loan," says Gibson. "If it is a loan, it should be formalized with a loan document." - Tap your home equity. A home-equity line of credit is another option, and it, too, sometimes comes without fees.
Pros: Home-equity loans tend to be relatively inexpensive compared with other loans; at this writing, $50,000 HELOCs carried an average annual interest rate of 5.5 percent—for people with an above-average credit score of 700 to 719. And the interest you pay may be tax-deductible.
Cons: Unlike a credit card, a home-equity line is secured by the equity in your home. In a brief financial emergency, drawing on a HELOC may be a reasonable solution, but if the emergency persists and you are unable to pay the money back, you risk losing your home. Another nasty detail: Interest rates are variable, so payments may spike upward, especially now while we are in an environment of rising rates.
How to do it: "Make sure to get a line of credit now, when you are not faced with an emergency, so that when one arises you can simply write a check," says Michael J. Garry, a certified financial planner in Princeton, N.J. Banks may be unwilling to lend you money, for example, after you lose your job. - Borrow against your securities. If you have a portfolio of stocks outside of your 401(k), you may not want to cash them in to bail yourself out.
Pros: Interest rates on a brokerage firm margin account tend to be significantly lower than those charged on credit cards: currently about 7.5 percent.
Cons: You may have to sell stocks when prices are low to meet a margin call from your broker. This situation is what caused people to leap out of windows after the 1929 stock market crash, although the number of leapers has been exaggerated in popular myth, and later rules on margin investing have kept people from getting in quite as much trouble. Still, unless you know how to fly, be careful.
How to do it: Set up a margin account with any brokerage firm with which you already do business. But, Garry adds, "only use it in an emergency." - Charge it to a card. Some planners suggest having one no-fee credit card in reserve, solely for financial crises. Because you won't be using it,
except in the unlikely event of an emergency, the interest rate is of less immediate importance than the fee, although that
can change if you run a balance over a prolonged period. You can compare no-fee cards at www.bankrate.com or www.cardweb.com.
Pros: A quick way to pay expenses.
Cons: The interest rates could make a loan shark cringe. The current average annual rate on a standard card is about 13 percent, and if you default on your payments, the rate on that card and others could shoot up to 30 percent or more.
How to do it: Put what you have to on plastic but give yourself a reasonable deadline for repaying the money. - Borrow against your 401(k) plan. If times are really tough, you may have to consider drawing down some of your long-term retirement savings.
Pros: Your retirement account may be your largest asset apart from your home, and since it's your money, borrowing is relatively easy. Generally, you can borrow as much as 50 percent of the money you have vested in the plan, up to a maximum of $50,000.
Cons: "The most obvious one is putting your retirement at risk," says Jean Fullerton, a certified financial planner in Manchester, N.H. Another big danger: If you lose your job—a financial emergency in its own right—the loan usually becomes due immediately.
How to do it: Ask your company benefits department for the forms. And bear in mind that you generally must pay the money back within five years.
