Most people, even those who have their personal investments planned out otherwise, sometimes fail to provide for an emergency. So, if you are not among the handful who have set aside funds to tackle such a situation, what recourse do you have if such a need arises?
By its very definition, an emergency is not predictable. And that is probably why it is often ignored. First, you don't know whether that situation will arise at all. Second, even if it does, you do not know when.
A contingency plan should be the first buffer against emergencies. Rishi Nathany, director, Touchstone Wealth Planners, recommends setting aside around three months' salary at age 30, six months' salary at age 35, one year's salary at age 45, and 6 months' pay after 55 years of age.
Only around 5 per cent of this must be stored in cash. "It is best to invest in low-risk, medium-return, liquid instruments like a savings or deposit-linked account or mutual fund floating-rate schemes," adds Kartik Jhaveri, director, Transcend Consulting India.
The problem is, given the way inflation and costs are going up, most people are disinclined to leave cash in low-yield products. And that is where the catch is. You have probably invested your money in products that may mature two years down the line. So, when you suddenly need cash, how do you raise it? We try and list the possible sources in decreasing order of cost.
Moneylenders. The traditional sources of emergency funds, they provide liquidity when you need it. But, since they offer unsecured credit 'no questions asked', their interest rates are among the highest and could be directly proportional to your desperation level.
The rates could work out to a killer 50-60 per cent per annum for unsecured loans. But Indians are historically against moneylenders, given the horror stories that abound about experiences with pawnshop dealers and jewellers. And these days, since banks offer a variety of financing options, it is best to give moneylenders a wide berth.
Credit card. In times of crisis it is easy to plump for cash on your credit card. But remember, it will charge you interest at close to 3 per cent per month along with the processing fee.
That is because, this too, is unsecured credit being given to you without question. Though really steep, this is useful too. It gives you instant access to cash (though only to the limit specified on the card). It also gives you the option to make immediate payments as well as some time in which to raise the cash to pay off the credit card debt. Remember that there is no free credit period and interest is charged on daily basis.
Cards are also useful in staving off the wolves when, say, you are abroad and need funds urgently. However, experts advocate crossing out your credit card payment with a personal loan if you are likely to take over 5-6 months to pay off the card bill.
Personal loans. The American entertainer Bob Hope famously said: "A bank is a place that will lend you money if you can prove that you don't need it." The irony is, when you desperately need money, the bank will probably give you the money, but compound your woes by charging 18-25 per cent interest per annum.
According to certified financial planner Amit Suri, this route should only be opted for "when you have exhausted all other avenues and you still need more money". Besides, it tends to take anywhere up to a week for banks to disburse the cash to you. In case of an old customer, the process can become shorter. Otherwise, it will go through the entire verification routine and the delay may be devastating. You may also consider a personal loan if you have the rare privilege of having a great relationship with your banker that enables you to obtain a significantly lower interest rate.
Before checking with the bank, it's best to find out if your employer has a policy regarding employee loans. S.K. Dutt, HR head (talent management and employer branding), Larsen & Toubro, says, "Several employers either lend money to their staff at low interest rates or subsidise bank loans at varying rates. Other organisations promote employee credit societies or have various forums to provide direct assistance to employees."
Distress sale of assets. While it is difficult to put a price on this, an example might help give an idea. After the death of his father in 1995, Vikram Phadke, 31, was forced to put his commerce degree on hold to take care of the family textile, steel and construction businesses (with a turnover of around Rs 25 lakh).
The companies started floundering because of his inexperience. Faced with a cash requirement of Rs 10 lakh (Rs 1 million), he approached various banks. But when the funds did come, it was a case of too little, too late. The fallout: Phadke had to sell off inherited property worth around Rs 75 lakh (Rs 7.5 million) at one-third discount.
To this day, he rues the circumstances that forced him to part with this prime property. "But I consider myself wiser today," he concludes. That is often how it is. Hard times can drive us to make irrational decisions. Selling off an asset in haste might fetch you the money you need, but there is no guarantee that you will get the amount you want for it, or that you'll be able to buy it back any time soon.
Borrowing against assets. Most experts agree that this is by far the best way of handling an emergency cash need, failing which, falling back on relatives or friends remains the best option.
Borrowing against assets is much better than making a distress sale since it leaves you with a fighting chance to free them from mortgages. Also, a collateral works wonders for the lender's comfort level and, so, lowers the amount he builds into the interest rate to take care of the risk. The downside is that it needs some time to process and that depends on what you are giving as collateral.
Overdraft facility. One of the cheapest ways of accessing cash is to have an overdraft facility on your bank account. It gives you almost instant access to cash with no extra paperwork. If you have term deposits, some banks will let you have overdrafts at 100-200 basis points over the term deposit rate. Charges vary, but you pay nothing till you use it.
Other assets you can pledge for a loan are your life insurance policy (not term), mutual funds, national saving certificates and government bonds, shares and securities and property, among others.
Here, too, it might make sense to go for an overdraft facility since you have the flexibility to not use the loan to the full extent and pay a lower charge. Most of the time, the loans against securities will cost 12-15 per cent, much less than personal loans. You will get a loan from the Life Insurance Corporation against your life policy for as low as 9 per cent (loan against a life insurance policy is more expensive from a bank). Loans against gold jewellery, too, are relatively easier on your pocket, at 12-13 per cent.
Different banks have different limits for borrowing against securities, that is, if you hold shares worth Rs 100,000, you might only get a loan worth 60 per cent of that amount. Therefore, before shopping around, do some research about the loan limit and charges levied by the bank.
You will need to work really fast to get the best deal. Remember, during an emergency, time is against you. "Your choice of the fund source will depend upon the rate of interest (other charges included) charged on different instruments, turnaround time for getting loan, the amount and duration of loan, repaying capability, and the pre-payment terms," says Suri.
For example, in case of a medical emergency, it is best to resort to a bank overdraft to withdraw funds. If the emergency is on the lines of a sudden job loss or a natural disaster, then you could probably go for a loan against financial asset or jewellery.
Similarly, a retired person may prefer selling an asset rather taking a personal loan; a young executive can consider the latter. The idea is to minimise jeopardy.
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