If you need money fast, who will you call?
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An unexpected expenditure or an emergency, which may require a large sum of money to address, may find you short of the required funds. When faced with such an emergency where do you turn to, to find the money urgently? The ideal situation is where you have access to an emergency fund that you have built over time, and which you draw on now.
You should aim to build a contingency fund of at least 3 to 6 months of income.
“The rule of thumb is that one should maintain a contingency fund of 3-6 months of her income. For a salaried person, 6 month’s income is a decent contingency fund. Those not having a fixed monthly income should plan for a fund equal to 1 year of income,” said Kavitha Menon, a Mumbai-based financial planner.
However, despite the best efforts towards making the financially prudent choice of first building such a fund, savings are often diverted to the urgent rather than the important, and the emergency fund remains a goal yet to be achieved.
In such a situation it becomes necessary to tap other sources of funds.
The ideal source for urgent cash is one that can be drawn or is available without any delay, does not have any costs or penalties attached to using it, and using the money does not affect other financial goals.
In some cases, such as selling investments or assets to raise the funds, there may even be a tax angle to be considered.The oft recommended emergency fund is one that meets all these specifications.
Use your investments
Even if you do not have a proper contingency plan, you should look around and think about the investments that you have made and the assets that you have. Dig into your existing investments or funds. These could be savings, fixed deposits, mutual funds or any such instruments. “Liquidating your investments could be the best option, as you can always build this again once you have a stable earning. Further, it is better than borrowing, as it will not create any financial obligations,” said Rajiv Raj co-founder and director at CreditVidya, a credit advice and planning company. An important aspect while looking for money at a short notice is, how quickly you can access it. Ultra-short-term funds or liquid funds come in handy in such situations. “If a family faces an emergency, it should be able to withdraw the money easily. For such purposes, I normally recommend ultra-short term debt funds or liquid funds. Money can be easily withdrawn from these options within 48 hours,” said Amit Kukreja, founder, WealthBeing Advisors.
Draw on your assets
Assets such as gold and real estate can also be used as security to raise funds quickly. The cost of such a borrowing is lower because this loan would be a secured loan. Money thus raised can be used as desired. But the procedures involved in this sort of borrowing are complicated and a little time consuming.
If you have the ability to repay the obligation, then taking a top-up loan or loan against property will be a better option. “The only downside here would be the stress on repayment if there is no regular earning. Also, the borrower has to be wary of the interest rates they would be servicing on such loans,” Raj said.
If you own a house, one way is to mortgage against it. Also, you can lease the house and move to a smaller house, said Menon. Gold is another investment that is very common in Indian households. “In case of loss of income, evaluate your financial assets. Most Indian families have gold, and it can be monetised,” added Menon.
The biggest risk while liquidating your investments or physical assets is that the markets in which you have to sell the investment, may be down and you may get a lower value for it than what you may have got if you had the time to allow the markets to recover. There may also be procedural and operational delays, which may mean that the money is not available immediately. Some investments, like listed securities, mutual fund units and bank deposits have shorter realisation periods relative to others.
Take a loan
If you have not got around to building a contingency fund or do not have, or have exhausted your investments, then the option available is to borrow. Although, reaching out to friends and family for meeting money exigencies is often considered the most common way in such a situation, it should be the last option and even then, a host of things need to be taken care of.
Menon said that in cases of emergency, a formal loan is not advisable, as it comes with repayment obligations. “It is better to ask family and friends to pitch in.” While this source is typically free of charge, there are other concerns in using it.
For one, your friends just may not have the money to lend to you when you need it, and you may have to pass the hat around to collect the amount you need. And without exception, borrowing money from family and friends puts a strain on relationships, especially if the repayment is delayed. Have a plan for repayment when you approach them for money and stick to it.
Credit cards are the most accessible and convenient source of urgent funds to meet expenses. You can use the card to pay for the expense and repay the debt when the credit card monthly payment has to be paid. You can also draw cash, if it required. But do not fall into the trap of borrowing through your credit card as it has many caveats. “Using a credit card should be the last option when faced with an emergency, because the interest rate on it is very high and you will have to repay pretty quickly. Instead, go for a personal loan as it is cheaper than a credit card loan. Use a credit card cautiously,” said Menon. The convenience and ease of using it is offset by the high interest that you have to pay on the debt.
A personal loan is a better option most of the times. Such loans can be accessed reasonably quickly, around 3 to 5 days, depending on the provider. There is no restriction on the end-use and the funds can be used for any need, including repaying credit card dues or informal loans from family and friends.
As these are unsecured loans, there is no need for any collaterals or guarantors. The flip side is that the interest payable on these loans is higher than secured loans. The amount of loan that you can access will depend upon the eligibility, level of income and ability to repay.
Another fact remains that in an emergency, the cost of money becomes irrelevant. However, every loan has to be repaid and defaulting on repayment has consequences, apart from the stress that it brings along. “Repayment of loans becomes critical, default on borrowed funds will put a lot of stress on the individual. Further, a delay in repayment may impact their credit score as well, which will have repercussions on getting loans in the future,” said Raj.
Accordingly, the lenders will also look at your repayment capacity. “For any kind of loan, they will look at how you will pay back. So, if there is no salary income, then the only option left is to borrow from friends and family,” said Kukreja.
Prepare for emergencies
Each option that is available to generate funds needed in an emergency, comes with drawbacks and limitations. Choose the one that suits your situation the best. You may even have to use more than one. Typically, the balance available in a savings account, credit cards and contributions from family and friends will be first used since you have immediate access to such funds.
However, the best way to meet an emergencies is to be prepared for it. An emergency fund, adequate life and health insurance, warranties and other general insurance products are the ways to be prepared and protect your personal finances in an emergency.