Ways to meet unexpected expenses
Tap the contingency fund, if the expense is small. If your requirement is high, take a loan against an insurance policy or even property
Most people would like to plan their expenses perfectly. But, more often than not, it is just not possible. There is this sudden travel, household expenses, car repairs, sometimes, a desire to buy a property which is coming dirt cheap that does tend to mess up that ‘perfect’ household budget.
Something similar happened with 42-year- old Vinay Chawla when a property that he really liked went up for sale. He had regular investments in varied products, but he was confused as to which one to tap for this purchase. Yes, a property purchase will not come cheap. But there can be smaller ones as well. Anita Yadav, 47, decided to make an unplanned expenditure on an expensive home appliance.
Clearly, both Chawla and Yadav went off their regular budgets, but there financial needs are remarkably different. And there are various ways to fund both. They can opt for equated monthly instalments for purchasing these or if they wish to save on the interest costs, they need to find the right instrument to sell or borrow against. Financial experts suggest that the ideal way to handle these kinds of situations is to dip into short-term investments and if possible, not to meddle with goal-oriented investments. “Goal- oriented investments or long-term investments should not be the first choice to fund these expenses,” says Tanvir Alam, founder, Finkart.com.
Bank account or emergency fund to rescue: Of course, the first thing that one should look at is the idle cash lying in banks. Idle cash with banks earn a very small interest rate of four to six per cent. So, unless it upsets your household budget drastically, use this idle cash to fund expenses.
Then, there is the emergency fund. Ideally, it is meant for dealing with loss in income in case of a job loss. But in certain circumstances, such as a small expense like Yadav’s home appliance, you could tap into it. “Cashing out your contingency fund for unplanned requirement should be your first option. It is an ideal place to start with,” says Suresh Sadagopan, founder, Ladder7.com.
A contingency fund is generally equivalent to three to six months of an individual’s monthly expenditure. In some cases, where the job is not very secure, or when there is uneven cash flow, a little higher amount is maintained for the emergency fund, around nine to twelve months’ monthly expenditure. This investment can be utilised to fund small-ticket unexpected expenses. Since these investments are usually kept in liquid or shortterm mutual funds for quick liquidity, funding such expenses through the contingency fund may not lead to any significant loss in interest income. However, it’s important to consider exit load on the scheme, tax implications and past performance and future potential of the scheme before exiting a scheme.
Dig deeper for a bigger expense: In case the requirement is not fulfilled with short-term funds or funds in the bank, look at other instruments in your investment portfolio. Look at mutual fund investments or direct stocks which are profitable. Booking some profits if you have a reasonably big portfolio can help you meet bigger expenses. For instance, if you are making an expense of ~500,000, profits from mutual funds or stocks can come handy. But remember that withdrawing from investments made in mutual funds that have completed a year would mean lesser tax incidence, as compared to the investments which have remained invested for less than a year.
But, say, like Chawla you are looking to buy a property, then things could be completely different. In this case, a life insurance policy from Life Insurance Corporation of India or other private sector players could come handy. The other option is a loan against property from banks or non-banking finance companies.
If you take the route of loan against an insurance policy, then the insurer will give up some percentage of the surrender value. Sometimes, this can be as high as 80 per cent in case of traditional plans. The interest charged is 10 per cent and above. In case of Life Insurance Corporation of India, the interest charged is nine per cent. If you choose this option, remember that you have to sign a deed which states that the benefits of the policy are being assigned to the lender. The policy is a collateral against the loan in such a situation.
However, don’t liquidate the policy. Accordingly to Lovaii Navlakhi, founder, International Money Matters, insurance is a long-term product that is usually taken up to fund important goals. Thus, liquidating these to fund any such unplanned requirement will not be an ideal choice.
Then, there is loan against property. If you have a residential or commercial property, you can leverage it. A housing finance company like HDFC will provide 60 per cent of the property’s value as loan. The interest rate would be around 9.75 to 10.5 per cent.