As useful as a personal loan is for helping you deal with unforeseen circumstances, they do place a debt burden on your shoulders. If more expenses arise, it becomes necessary to budget around your personal loan repayment needs. A contingency plan helps you ensure that you can manage your debt obligations even when unexpected challenges arise.
Let’s go over why a contingency plan for personal loans is important, how to make one, and key factors to keep in mind when contingency planning.
Importance of having a contingency plan for personal loans
There are many benefits associated with creating a contingency plan when you have taken out personal loans. Here are the main reasons why it is crucial to build a good personal loan contingency plan.
1. Mitigate risks
An effective contingency plan can help you greatly mitigate potential risks that come with emergencies and debt. If something unexpected occurs, your loan repayment plan can become more difficult than ever to manage. If you fail to meet your repayment terms, you might be charged penalties, your credit score might plummet, and your loan might go into default.
2. Boost your financial stability
Financial stability plays a large role in your life. By having a contingency plan for how to handle your loans in case of an unforeseen circumstance, you can maintain better financial stability. If you need to dip into your emergency savings, the contingency plan can prevent you from losing your ability to make monthly loan payments.
3. Avoid defaulting on personal loans
By failing to meet your designated repayment terms, you might end up with a loan default. Defaulting on a loan has grave financial consequences, negatively impacting your ability to receive credit extensions or loans in the future. A loan default remains on your credit report for up to seven years, hurting your opportunities.
A contingency plan assists you in staying on top of your personal loan repayment schedule even if something unexpected and financially disruptive takes place.
Identifying potential financial risks and emergencies
By familiarizing yourself with financial risks, you can see red flags and be proactive about protecting yourself. It’s a good idea to monitor your cash and credit usage each month and be aware of your spending patterns.
Unfortunately, in our unpredictable world, emergencies rarely announce themselves before taking place. If you encounter an emergency that requires your urgent attention, it may clash with your usual life goals and priorities. In this case, it can be helpful to fall back on your contingency plans and regain control of the situation.
Common emergencies that may impact your finances include:
- Medical emergencies
- Car accidents
- Natural disasters
- Severe weather
- Urgent house repairs
Creating a budget for unexpected expenses
1. Track your typical expenses
Knowing your current expenditure patterns can help you identify unexpected shifts, categorize your spending types, and know how much of your income is spent each month. If you have never tracked your spending before, you may want to begin by noting down your expenses for a month.
2. Categorize your expenses into necessary and unnecessary
Not all expenses are considered necessary. Some are luxury or excessive and can be eliminated from your monthly expenditures if they are straining your budget.
Common necessary expenses include:
- Housing (e.g. rent)
- Utility bills
- Debt payments
Even though many borrowers believe that it is acceptable if a debt payment is late, it is advisable to consider loan installments as necessary expenses. While it is not the end of the world if you miss a debt payment, regularly failing to meet your repayment schedule can have damaging effects to your credit score and financial health.
3. Identify fixed and variable expenses
Some bills are fixed, in that they barely vary in costs. Common fixed bills include:
- Rent payments
- Insurance premiums
- Cell phone data
- Internet services
Other bills are variable, such as:
- Entertainment and recreation
- Shopping for luxury goods
- Dining out
- Medical expenses
Emergency fund management and allocation
An emergency fund is similar to a contingency plan. Emergency savings are typically placed into a bank account that is separate from your usual accounts. An emergency fund should contain enough money to cover at least three to six months’ worth of necessities and living expenses.
Generally, even as you budget toward debt repayment, it is a good idea to allocate a percentage of your income to build up a healthy amount of emergency savings. Over time, you will be more familiar with your own risk appetite, budget flexibility, financial obligations, goals, and needs. This will allow you to better gauge how much to put into your emergency savings account every month.
Insurance options for personal loans
Insurance products exist to give borrowers an additional layer of protection after obtaining a personal loan. Here are some of the most common personal loan-related insurance types you might encounter.
Credit life insurance
This kind of insurance is meant to pay off outstanding debt in case the policyholder passes away. The policy term of credit life insurance typically corresponds with the tenure of the loan you want to insure.
If you take out a large loan, such as a mortgage or an auto loan, you might be offered credit life insurance at the time you sign the loan agreement.
In general, credit life insurance is only worth considering if you have a loan co-signer who is sharing responsibility for your debt, or if you have dependents who would benefit from your life insurance policy.
It’s important to do research and carefully review credit life insurance policy terms before you agree to purchase the policy. In some cases, your dependents and heirs would not be obligated to finish paying off your personal loans if you die before the loan is fully repaid.
Credit involuntary unemployment insurance
Credit involuntary unemployment insurance kicks in if you lose your full-time job, but you are not found at fault. Common situations where this kind of insurance can be beneficial include:
- Company layoffs
- Unionized labor disputes
- Employee lockout
- Involuntary employment termination
Credit disability insurance
Credit disability insurance policies cover various forms of disability as outlined in the policy terms. If a disability prevents you from being able to adhere to your loan repayment terms, this kind of insurance may be helpful. However, since it is a rather specific type of personal loan insurance, you may want to first consider other kinds of loan protection.
Reviewing and updating contingency plans regularly
Even if a contingency plan is amazing and comprehensive at the time of its creation, it’s always a good idea to review it regularly. That way, you can make adaptations as needed.
When reviewing your personal loan contingency plan, consider various factors such as the following:
- Has your income situation changed
- How much of your loan still needs to be repaid
- Are there significant changes in your emergency savings
- Are you struggling with your loan repayment schedule
- Have your priorities and goals shifted
Seeking professional financial advice for contingency planning
Professional advice from a financial advisor can be worthwhile if you are in the process of creating a contingency plan or budget for your personal loans. Experts can give you personalized counsel that addresses your needs, goals, and current financial situation.
If you’re considering seeking professional advice, first take steps to find a suitable, qualified advisor with a good reputation. Many certified financial planners offer consultations to determine whether your needs align with their capabilities and expertise.
What to discuss with your financial counselor?
Information you should share with your financial advisor may include:
- Your income
- Debt obligations
- Open credit accounts and balances
- Any challenges you are currently facing
Strategies for managing unexpected income changes
Unexpected income changes can disrupt your financial planning. Changes in income may come from various causes, such as job loss, career change, demotions, or recessions. In many cases, unexpected income fluctuations result in the need for stricter budget and monetary management.
To better prepare yourself for financial fluctuations, here are some strategies that may be helpful to you.
Prioritize necessary expenses
Make sure that your savings go toward your necessary bills before you consider using your funds for unnecessary expenses. Rent, debt payments, food, electricity, and phone services are some of the more essential expenses.
Cut back on variable or unnecessary expenses
If you have subscriptions, memberships, or other unnecessary expenses, these are typically the first ones that can be cut if you need to manage your new income situation. Adjusting your luxury or excessive spending habits can help you better face your unexpected income shifts.
Don’t overspend your money
If you have received a promotion or windfall income, it may be surprising to hear that unexpected increases in income can also impact your financial management strategy. Many people who gain unanticipated income struggle with budgeting and end up spending excessively. This can lead to the mishandling of personal loan debt.
It’s often advisable to carefully review your needs, goals, and spending habits after gaining a raise in income. Make sure that you do not forget about your debt repayment plan, and consider loan prepayments to pay off your debt more quickly.
Revisit your budget and situation over time
It is common for people who face unexpected income changes to feel unsure and stressed about how to tackle their necessary expenses and new budget needs. Some individuals become overly strict with their expenditures, whereas others misjudge how much they now need to save every month.
As time passes, revisit your financial situation, monthly spending, and budget. Make revisions accordingly to help yourself adapt to your new income or employment variations.
Balancing debt repayment and emergency savings
As you work toward repaying your debt, it’s critical that you don’t forgo saving for emergencies. Ideally, you should balance paying debt installments with saving for your emergency fund. To achieve a happy balance, here are some factors to consider:
Your current financial situation
It is essential to take make an overall assessment of your situation. Take stock of what debts you have, list out your minimum monthly payments, and note down the interest rate associated with each account. This can help you determine which debts need to be repaid the most urgently.
Identify high-priority debt
Some balances and debt obligations are more pressing than others due to their nature or high interest rates. Allocate most of your attention to the highest priority financial obligations. Compare the interest rates on each of your debt obligations to discern which ones be paid off first.
Generally, credit cards and high interest personal loans should have high priority. If you don’t make these payments on time, you might rapidly start to accumulate heavy interest.
A goal for your emergency fund
The general rule of thumb when it comes to saving up for your emergency fund is that the account should contain enough money for three to six months of living. This means that in case of sudden job loss, emergency repairs, medical bills, or other urgent expenses, you will still be able to cover living expenses for a good period of time.
Calculate how much your monthly living expenses cost and multiply it by several months to find the goal for your emergency savings.
It can be hard to stop yourself from dipping into your emergency savings. If you want to be more adaptable with your savings but are worried about unforeseen occurrences, consider cultivating a rainy day fund. This can serve as a buffer between your emergency fund and your regular bank account.
Reach a balance between debt repayment and savings
The optimal balance should allow you to comfortably make regular, on-time debt payments while also gradually working toward a sizable emergency fund. Finding this balance can greatly improve your financial stability.
Utilizing credit cards as a backup plan in emergencies
While maxing out your credit cards is not generally advisable, using your credit cards in emergencies can be a valuable backup plan. Emergencies often require you to pay bills urgently. Otherwise, you wouldn’t be able to adequately handle the new circumstances. In a pinch, it might be beneficial for you to turn to your credit cards or same-day personal loans to face the sudden challenges.
Personal Loans Company Reviews
Recently Updated Articles