It is estimated that most American Families can only maintain their current living expenses for 60 days or less when their income is interrupted for any reason.
My financial counselor, Dave Ramsey, provides a 6 step plan to financial success. The first step is to sock away $1000.00 in an account that’s very easy to draw upon in times of emergency while you work hard at step 2. The reason it’s only at $1000.00 is because the debt that you may be carrying, which is knocked out in step 2, needs your full financial attention before you build your full emergency fund of 3 to 6 months living expenses. That’s step 3.
If your monthly expenses are $2000.00, then you need to have $6000.00 – $12,000.00 in reserve just for emergencies. This money should be in an account you have quick and easy access to, and should be used ONLY for true emergencies. A prom dress is not an emergency and niether is a vacation.
If you don’t have this, you are like most Americans with a mere 60-days worth of reserves. To make matters even worse, a majority of those people will rely on credit card limits to continue to carry them past the 60-days, which will send them diving into a spiral of financial defeat.
That is distress. So, what are some of the causes of financial distress? Hopefully the following 16 points will give you a greater understanding of what causes the distress that you may be right in the middle of.
1. Payment Increase or Mortgage Adjustment
Currently, this is the most common reason for financial distress. Billions of dollars of bad loans were written during the most recent real estate boom, and many of them were “creative products” designed to bring borrowers who couldn’t normally afford to buy a home into the home-buying game. Now that those products are adjusting, the result is typically a payment that the borrower can no longer afford. The tragic part is that the terms of the loan make it clear that the adjustment is part of the plan, yet most home owners do nothing to prepare for the change.
2. Loss of Employment
No income? No payment. If you lose your job, in most cases, unless you’re fortunate enough to receive a severance package, you are without income immediately. This will suddenly become a source of seemingly insurmountable stress.
3. Business Fails
For the self-employed, your income depends on your skills as an entrepreneur, and the market you’re in. Without a solid contingency plan for your business finances, the loss of your business also means the loss of your income.
4. Unexpected Damage to Property
“It will never happen to me.” Sure it won’t. When there’s damage to your home, it will cost you. When your insurance company fails to provide for the full amount of your claim, you’ll be left filling the gap, which in many cases exceeds 60 days reserves.
5. Death of a Spouse
One of the most devastating life experiences is the loss of a loved one, especially if they were the primary income earner in the family. This is why it is critical that you have a plan in place and have proper life insurance for your situation. If your primary wage earner dies, it’s just like losing your income, instantly.
6. Death of a Family Member
When a family member who is not earning income dies, it is emotionally devastating and the ripple effects will spread throughout every area of your life, affecting your work, your business, and your relationships. This can produce undue stress and affect your earning ability. It may even lead to needing to support survivors which will increase your costs.
7. Severe Illness
No insurance for that cancer diagnosis? Good luck covering your costs with 60-days reserves. Illness can lead to extremely high medical debt and loss of income during recovery. Disability insurance and health insurance are two very important planning products that you need to consider to avoid distress as a result of severe illness.
Believe it or not, an inheritance isn’t always a blessing, especially if it’s happening in the midst of grieving from an unexpected family death. If you inherit a home that isn’t paid for, you inherit the debt and the expenses of keeping it up as well. Your 3 to 6 months of reserves will need to be much higher now. Even if the property you inherit has significant equity, carrying the cost of maintaining it and paying the remainder of the mortgage may lead to foreclosure.
This is an extremely common reason for distress. It can be an emotional and expensive situation to be in. Spousal support, child support, attorney’s fees, etc., can all lead up to distressed finances.
One step below divorce is separation, and it can strain a 2 income earning household as housing costs will typically double, and now the person left holding the big house will no longer be able to afford it.
Sometimes your employer will require that you move, which may mean you’ll have two households to maintain. Again, your costs just doubled, and even though you may be able to rent out your current residence, in this market, it’s unlikely that you’ll be collecting more in rent than you’re paying in mortgage payments. Your relocation may end up adding an entire household’s worth of expenses.
12. Military Service
Except for relief provided in very specific situations by the Servicepersons Civil Relief Act (SCRA), military service can lead to unexpected financial issues. There are thousands of service personnel who have had their periods of active duty unexpectedly extended and are now suffering a tremendous amount of financial pressure.
13. Insurance or Tax Increase
With only 60 days of expenses on hand, if that annual tax bill goes up, or an unexpected increase in insurance premiums occurs due to a claim, you’ll be draining that reserve much faster, and that can cause distress.
14. Too Much Debt
Mortgages, Credit Card Debt, Auto Loans, Student Loans. These are all weighing millions of Americans down. If you graduate, you now have additional payments to make if you haven’t deferred your student loan payments. Your credit card rates may be unexpectedly increased, etc.
15. Reduced Income
There’s always the possibility that your commissions will be less than they were last year due to the economy, or your company may scale back and reduce bonuses or even reduce your salary.
How are you going to make a living from the slammer?
Many of these are no-brainers, but the key to avoiding the distress that results from any of these is to have a plan, make sure you have the right insurance in place, pay off all of your debt, and keep a healthy emergency fund of at least 3 to 6 months living expenses socked away.
Most of these are things that “will never happen to me.” Well, that’s just not true. You never know what will happen from one day to the next, but you can be sure that if you have a plan, you will not find yourself looking for a way out of foreclosure.