In Case of Emergency

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I was raised by a “Save for a Rainy Day” parent, but I live in a “Buy Now, Pay Later” world. The two philosophies are not easy to reconcile, but I try.

With so much purchasing peer pressure placed on us (try saying that ten times fast!), the thought of directing any of our limited disposable income to an emergency fund sounds about as appealing as trying to find a parking spot near The Keg on a Friday night in downtown St. John’s. We all know we need to save for our retirement and for our kid’s education, but for an emergency too...really?

Really.

Just to be sure we are all on the same page when it comes to what constitutes an “emergency,” I took the liberty of googling.

Emergency – A serious situation or occurrence that happens unexpectedly and demands immediate action.

Let’s break this one down, shall we?

The first element of this definition is “serious.” Needing special orthotic inserts that your health plan does not cover may be serious. Needing another pair of designer shoes to put them in, not so much.

The second element is “unexpectedly.” Contrary to the frenzy at many service stations this week when Mr. Snodden hinted there could be snow, needing new snow tires in this province in November is not an unexpected event. Every year we know that winter is coming and every couple of years we know new snow tires are coming right along with it.

Finally, the need for “immediate action.” This is the main reason why we need the money at our fingertips in the first place. Not next pay day, but immediately. Experts suggest having the equivalent of three months of salary set aside in case of an emergency. Others suggest having enough to cover at least three to six months’ worth of necessary living expenses (emphasis on necessary). Either way, they all say it is important and they are all right. And I agree with them.

But I also live in the real world.

Here’s what I’ve learned from my clients and from my own trial and error. The habit of saving is more important than how much we save.  Whether that’s having a spare change jar or a payroll deduction that gets directed to a TFSA, whatever works for you, works for you. By starting the habit early and practising and perfecting that habit over a lifetime, the dollars will eventually add up.

In the meantime, if a real emergency should strike before you’re where you should be, the next best thing is to have access to cheap credit. That means having a credit line or home equity line of credit (HELOC) in place before you need it. In essence, this allows you to borrow money for less than a credit card would cost.

This is not to be perceived as a free pass or a blank cheque. It is not a permission slip signed by the lender to “go mad” and have yourself a wild old spending time. It’s this type of behaviour that has given these forms of credit a bad rap. It’s often not the tool, but the user that leads to trouble. It is still meant for emergencies only (refer to definition above if you need a refresher). And you should only use this type of credit if you are committed to repaying what you borrowed within 6-12 months of the serious, unexpected event that lead to the borrowing in the first place.

The only exception to this emergency rule is if you use a credit line or HELOC to pay off any higher interest debt you have. But even then it only works if you are going to direct the money you save in interest towards either paying your overall debt down faster (freeing up the credit if its ever needed for a future crisis) or putting it directly into a “just in case” account.  Or better yet, do a little of both.

Let’s assume you were paying $500 per month on a credit card and $1000 per month on a mortgage. You use a HELOC to pay off the credit card debt at 19.99% interest and blend the balance with your 3.50% mortgage. Now lock up the credit card (seriously, find yourself a locked drawer and throw that thing in there) and continue to make the same $1500 monthly payment. Except now increase your mortgage payment to $1200 per month and direct $300 a month to a separate savings account. Regardless of the differential between interest you could earn on the savings and interest you would save on the debt, I personally prefer this option. That’s because it still reduces your overall debt, while solidifying the savings habit.

And let’s face it, there is nothing more likely to keep you committed to a contingency plan as the accumulation of cold, hard cash.

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