A personal financial crisis can cause a great deal of stress, worry, and lost sleep. It upsets your quality of life. Even the thought of it happening can have this effect.
Most people don’t think about avoiding a personal financial crisis until they’re in the midst of one. But there are plenty of actions you start taking now. As we near the end of a challenging 2020 and head into 2021, now is a good time to prepare for the possibility of a personal financial crisis.
Here are six examples of a personal financial crisis and how to avoid each of them.
Debt is the first financial crisis to address because it often causes or compounds the other situations on this list. Here are ways to you avoid getting into personal debt that becomes too large to dig out of:
- Make a budget and stick to it.
- Live below your means. Don’t buy a home or car that barely fits into your budget. Instead, give yourself wiggle room when you borrow for big-ticket items.
- Limit your credit card use. Racking up credit card debt is one of the easiest ways to wreck your finances. While it may be necessary to use a credit card at times, it should be a last resort. Avoid using credit cards for vacations and entertainment expenses. If you do use a credit card, try to pay the full balance each month to avoid interest charges.
- Include saving money in your budget. This helps in two ways. First, it helps you to spend less than you make. Second, you can draw on your savings when unexpected expenses pop up instead of borrowing to pay for them.
- Build a respectable emergency fund. This is a specific type of savings you use for emergency purposes only, such as a period of unemployment or unexpected medical expenses.
[ Related read: How to live within your means ]
Medical debt is a different category than personal debt because it usually accumulates out of no fault of the person in debt.
Even if you have health insurance, it’s possible to accumulate significant medical debt. Many medical plans cover 80 percent of the cost for procedures and treatments. That leaves you accountable for the remaining 20 percent. Therefore, if you suffer an ailment that costs $100,000 to treat, your insurance company will pay $80,000, leaving you with a $20,000 balance.
You can potentially avoid medical debt by adding supplemental insurance plans. In addition to health insurance, you may want to consider:
- Critical illness insurance, which pays a lump sum benefit if you are diagnosed with a covered illness.
- Hospital indemnity insurance, which helps cover the costs of a hospital admission that may not be covered by other insurance. It typically pays a lump sum directly to you, not a hospital or medical facility. That means you can use the benefit for any purpose, whether to cover the cost of care or for a non-related purpose.
- A health savings account (HSA), which is a tax-preferred savings account that enables users to set aside tax-free dollars to pay for health expenses, including regular medical care, dental and vision expenses. It can only be used in conjunction with a high-deductible health insurance plan.
[ Related read: How to get rid of medical debt ]
When debt becomes too great, many people think the best solution is filing for bankruptcy.
However, it’s better to avoid bankruptcy if possible. Filing for bankruptcy has a detrimental effect on your credit score and will make it more expensive and more difficult to get loans.
Before you file, try these methods to avoid bankruptcy:
- Cut your expenses down to the bare essentials and apply those savings to repaying debt.
- Negotiate with creditors. Companies you owe money to don’t want you to file for bankruptcy because it may make it more difficult for them to recover payment. If you explain your situation they may be willing to lower your interest rate or extend your payment term to make the debt more manageable.
- Enlist a debt management service. This type of nonprofit service can negotiate with your creditors and help you improve your finances. Don’t confuse this type of service with debt settlement, which charges high fees to lower your debt obligation to creditors.
- Consolidate your debts. Debt consolidation combines several unsecured debts, such as credit cards, medical bills, and personal loans, into one bill with a single monthly payment. This can make the debt more manageable and potentially lower the amount of interest you pay each month.
Unemployment is another one of those situations that is usually out of your control. But you can possibly avoid the negative consequences with some preparation now.
In addition to the steps listed above, such as making a budget and having an emergency fund, another way to avoid the effects of unemployment is to have a side gig. Having multiple income sources can be an advantage during uncertain times.
Thanks to technology and the gig economy, there are a number of possible side hustles that are flexible enough to work around your current schedule. Examples include driving for Uber, delivering meals for Grubhub, serving as a virtual assistant for several clients, and writing a regular blog that generates ad revenue.
[ Related read: What to do when unemployed ]
The risk of losing your home becomes greater when one of the above financial crises hits. Therefore, addressing these potential issues can help you avoid home foreclosure.
Here are a few steps to help you avoid this:
- Contact your lender as soon as you have trouble. Lenders don’t want to foreclose, so they may work with you to help you through a difficult period.
- Research your prevention options. The Federal Housing Administration offers valuable information about foreclosure prevention.
- Contact a housing counselor. The U.S. Department of Housing and Urban Development (HUD) funds free or low-cost housing counseling nationwide. Housing counselors can help you understand the law and your options, organize your finances, and represent you in negotiations with your lender if you need this assistance.
Having no savings when certain events occur is a helpless feeling. The best way to avoid this financial crisis is to save as much money as you can as soon as you can.
This is especially true for retirement saving. If you start full-time, professional work in your early 20s, you have 40 to 50 years to save enough money to live on in your retirement years. This sounds like a lot of time, but it passes by quicker than you expect. Even setting aside small amounts in your younger years will help you accumulate retirement savings.
[ Related read: How much money should I have saved? ]
The main lesson when anticipating or enduring a personal financial crisis is not to ignore the problem and hope it goes away. It never will on its own.
Plan ahead, establish a solid financial foundation, and be prepared to make sacrifices to avoid a personal financial crisis.
Joel Palmer is a freelance writer and personal finance expert who focuses on the mortgage, insurance, financial services, and technology industries. He spent the first 10 years of his career as a business and financial reporter.
The information and content provided herein is for educational purposes only, and should not be considered legal, tax, investment, or financial advice, recommendation, or endorsement. Breeze does not guarantee the accuracy, completeness, reliability or usefulness of any testimonials, opinions, advice, product or service offers, or other information provided here by third parties. Individuals are encouraged to seek advice from their own tax or legal counsel.