You probably heard that you need to save up an emergency fund – and you’ve heard it over and over again. Without a savings buffer, when something seemingly minor goes wrong, say the fridge breaks, the car needs to be fixed, or you receive a surprise parking ticket, your solutions for dealing with these problems are all limited and carry risk. But with living costs rising faster than salaries, this is often just not feasible – in fact, 40% of working age Britons have less than £100 in savings. This is not a flaw of character, it’s a flaw of the times we live in. And when you barely make ends meet, the last thing you need is patronising advice about saving. What you really need is an emergency plan.
Did you know that there aren’t really any great solutions to this problem?
Without savings to dip into, your options are pretty much limited to: 1) using your overdraft, 2) using your credit card, 3) borrowing from friends or family or 4) taking out a personal loan.
Let’s explore the problems with these solutions:
Dipping into your overdraft is probably the most common way of solving unexpected expenses. It’s easy, and it’s quick. If your washing machine breaks, you can get a new one right away. But it can be risky. Most people are not aware of the true charges of overdraft – which can sometimes be even higher than a payday loan. And because many find it hard to get out of overdraft, these charges then build up and up and up.
Did you know that banks make approximately £300 per year on average per customer on overdraft charges? Did know that over 50% of overdraft users underestimated their usage by two or more months? And more than a third were not even aware that they went into overdraft?
Do you really know how much you are getting charged? (Hint: you should probably check)
In our opinion, credit cards are currently one of the most cost-efficient ways to deal with unexpected expenses, but they come with a different unique risk – namely, the risk of persistent debt and the fear of abuse. In fact, when we asked people how they would deal with an unexpected expense, we were surprised to find that most people did not choose their credit card – after all, it’s cheaper than most alternatives. But the reason they didn’t is that many had troubles with credit cards in the past and they were scared to use them again. They thought of credit cards as almost a last resort.
The other problem with credit cards is that many people, living on a tight budget, are tempted to buy something and just set it on the minimum payment. The problem with this is that it will take years to clear, and cost you significant amounts of money along the way. If you put a £250 unexpected expense on your credit card and set the minimum payment it will take approximately ten (!!) years to clear and will cost you approximately £450 in interest charges (for a total repayment of £700!). That’s for a 40% near prime credit card. For ‘prime’ credit cards, charging 20%, its still a big number, 7 years. That’s like paying almost £2 in interest for every £1 you put on a credit card.
Borrowing from friends and family
Borrowing from friends and family is definitely the cheapest way to deal with an unexpected expense, but usually the least practical. With 40% of the country having limited savings, many times your friends and family won’t be in a position to lend you the money. And if they do have the money, it can be very embarrassing to ask. People without savings are sick and tired of moralisers telling them to try harder to save and its hard having the people closest to you saying, ‘I told you so.’ Many people we spoke to mentioned that asking their friends or family would only be an option if they had exhausted all other solutions, including payday loans!
Taking out a personal loan
Taking out a personal loan to deal with an unexpected expense is fraught with risks. Because you need the money now, you won’t have the luxury of going to a high street bank or credit union, since that process can take days or weeks. On top of that, because the amount of money you typically need to borrow is relatively small (£200-500), most banks won’t even give that. So pretty much your only personal loan options are to look at a payday loan. Payday loans will give you the money, and give it to you quickly and anonymously, but the risks are very, very high. The costs can be what some may call exorbitant- the APRs can be over 1000%. And the debt collection processes can be invasive and painful.
Did you know that you are twenty times more likely to end up with severe debt problems if you take out a high cost short-term loan to deal with an unexpected expense?
Given the risks associated with the solutions to unexpected expenses for people without savings, and given how many people this affects, we are happy to see some new companies trying to tackle this problem. Companies like Chip and Plum are making it easier for people to save. Meet Cleo is trying to help people budget. Creditspring, one of the newer London start-ups, is specifically focused on solving the problem of unexpected expenses. They are working on developing a simpler, safer and cheaper alternative to overdrafts and credit cards.
As more companies focus on the problem, we are hoping awareness will increase along with solutions.