Here’s how to figure out an emergency cash option if you’re faced with a short-term, urgent need to cover unexpected expenses.
In an ideal world, you’d be able to put enough away in an emergency savings fund so that unexpected expenses wouldn’t cause a panic. But for too many people, just starting an emergency fund feels out of reach: 22% of adults have no emergency savings at all.1
What do you do if it feels like you have zero options? Here’s the financial impact of six ways to pay unexpected bills.
1. Secure a bank or credit union loan.
This will require you to provide financial history, including credit score. You may also have to secure the loan, meaning back your repayment pledge with an asset.
The impact on your money: Interest rates are quite high, relatively, and you may have to pay fees and jump through qualification hoops. In addition, you’ll have to adjust your budget to pay back the loan on time. But the turnaround time between application and approval may be quick, depending on your history and credit score.
1. Secure a bank or credit union loan.
This will require you to provide financial history, including credit score. You may also have to secure the loan, meaning back your repayment pledge with an asset.
The impact on your money: Interest rates are quite high, relatively, and you may have to pay fees and jump through qualification hoops. In addition, you’ll have to adjust your budget to pay back the loan on time. But the turnaround time between application and approval may be quick, depending on your history and credit score.
2. Apply for a home equity loan.
The amount of your home that you own—your equity—serves as collateral for a loan.
The impact on your money: While home equity loans sometimes have lower interest rates than bank or credit union loans, you still may pay fees such as appraisals and underwriting, which are added to the overall loan balance. And you must budget for the repayment amount over the repayment term. As with bank loans, these may offer quick turnaround.
3. Establish a home equity line of credit.
Similar to a home equity loan, but with a variable repayment and interest rate so you can borrow what you want, when you want it.
The impact on your money: In addition to budgeting for home equity line of credit repayments, this option often has a variable interest rate, so the cost of the money you’re borrowing may go up (or down). If you have a relationship with a bank, you may receive quick approval for these, too.
4. Use a credit card.
Various options exist, including zero-interest credit cards, which often begin charging interest once the initial offer expires.
The impact on your money: The fine print often describes late fees and charges that you may be unaware of. Just having more credit cards may also negatively impact your credit score. And you’ll need to budget enough to make progress on your credit card principal balance to eliminate the debt. But, if you can find a card with short-term zero-interest and pay off the balance quickly, you’ll save yourself charges.
5. Take out a 401(k) loan.
If permitted by your plan, this is a loan you take from the savings you’ve accumulated in a 401(k) plan. As with any other loan, you are required to pay it back over time.
The impact on your money: There are limits on 401(k) loan amounts, typically a $50,000 max or 50% of your account within a 12-month period. However, there are no taxes and penalties, as long as you pay back the loan within five years. If you leave your job, you must repay the loan (typically within 60 days) or face a 10% penalty if you’re under age 59½. Finally, the money you borrow means you lose out on potential growth in your retirement savings.
6. Make a 401(k) withdrawal.
Unlike a 401(k) loan, a 401(k) withdrawal permanently removes money from your retirement savings with no intention of paying it back.
The impact on your money: 401(k) withdrawals are subject to an early withdrawal penalty of 10% as well as income taxes on the distribution. For example, if you withdraw $50,000, you may pay $17,500 (35%) in taxes and penalties and keep $32,500 (65%). (There are exceptions to the 10% early-withdrawal penalty that could apply depending your age and work status; speak with a tax advisor about your situation.) As with a 401(k) loan, you’re also disrupting your ability to earn compound interest on your retirement savings—but in this case, you’re not returning the money to eventually recapture some of that growth.
What's next?
If you’ve made saving in your retirement account a habit, consider if you apply that same habit to starting a small emergency fund. How much are you saving for the long term? Log in to principal.com to check your savings rate. Don’t have an employer-sponsored retirement account or want to save even more? We can help you set up your retirement savings with an individual retirement account (IRA). Ready to learn more ways you can build your financial foundation? Our learning library can help.
