You've probably heard before that having an emergency fund big enough to cover three to six months of essential expenses is a sound financial move, but what incentive do you have to set money aside for something that may not happen?
Thinking about the consequences of not having an emergency fund is one way to recognize the incentive of setting some money aside for the unexpected. A Federal Reserve survey of household finances found that over 40 percent of Americans could not readily pay for an unexpected expense of $400. The problem is, if you can't take that kind of setback in stride, it can magnify the problem and turn a moderate expense into a larger one.
6 consequences of not having emergency funds available
Here are some ways an otherwise manageable problem could get worse if you don't have emergency savings available:
- Credit card interest could compound your expense
According to the Federal Reserve survey mentioned above, for people without enough money set aside for emergencies, the most common alternative for handling an unexpected expense is putting it on a credit card and paying it off over time. But credit card debt is an especially expensive form of borrowing and, with credit card rates having risen by more than 3 percent over the past two years, it is quickly becoming even more costly.
- Trouble paying your bills could damage your credit rating
Putting an unexpected expense on a credit card only delays the problem. You still have to pay that credit card balance off and, if you struggle to do it, that could damage your credit score. The lower your credit score, the higher your credit card interest rate is likely to become, further compounding the problem.
- Loss of access to utilities
The Federal Reserve survey also found that utility bills are one of the things people most frequently skip paying or only partially pay when they are short of money. This is risky business - doing without water or heat could put you and your family in serious jeopardy. Keep in mind that a shaky history of paying your utilities at one residence can make it more difficult to get service at a future residence.
- Loss of housing
The stakes really get high if a financial emergency forces you to miss a rent or mortgage payment. Now you are putting your housing situation in danger. This should be thought of as one of the great incentives to have an emergency fund. During hard times, that extra reserve can help keep a roof over your head.
- Car trouble causing you to miss work
One of the most common real-world financial emergencies is car trouble that necessitates an expensive repair. If you don't have the money to pay for that kind of repair, or if tight finances cause you to delay routine maintenance and lead to more serious car problems, you could suddenly find yourself without transportation. If this causes you to miss work, you will be facing a hefty mechanic's bill and lost income at the same time - all because you did not keep emergency savings at the ready.
- Skipped medical treatment can lead to complications
Another item mentioned in the Federal Reserve study was that more than one-quarter of Americans forgo some form of medical treatment each year due to cost - and this percentage goes up when the economy is weaker. In this sense, your body is like a car - putting off dealing with an issue can only exacerbate the problem and the resulting consequences.
Neglecting your health can lead to more expensive medical treatment being required down the road, and possibly a loss of work in order to pursue that treatment. On top of those economic consequences, of course, you would also have to deal with the personal misery and risk of lasting damage to your well-being.
Remember, setting money aside in an emergency fund doesn't mean that money is lost to you. In fact, if you choose wisely with a high-interest savings account or possibly even a CD with a modest early withdrawal fee, that money can be actively working for you, earning interest. That means your emergency fund can make you money in good times and, as the list above demonstrates, it can also save you money in bad times.