Why it pays to have a financial safety net for the unexpected -Sarah Coles

And while I’m pretty sure this feature is unique to my car, I know I’m in good company when it comes to unexpected expenses, because our research shows that two in five people run into at least one every year, costing an average of almost £2,000. How we cover these costs can have a profound impact on our finances.

The good news is that the same research showed the most common way to cover the cost is through savings – which almost half of people opt for. It’s why having an emergency savings safety net is such a godsend. As a rough rule of thumb, we should all aim to hold 3-6 months’ worth of essential spending in an easy access savings account for these emergencies. This is a sizeable enough sum to cover one or two horrible surprises. Alternatively, it can cover the absolute necessities if you’re unable to earn anything for a short period.

In retirement, the recommended minimum grows to 1-3 years’ worth of essential spending, because when you’re on a lower fixed income, and unable to make up any shortfall through earnings, you need much more wiggle room. This is particularly the case if you’re using drawdown to take an income from your pension, because you may not want to take as much from your pension when investments fall: this emergency fund can cover your needs in the interim. If these figures seem impossibly high, don’t let it put you off. The aim is to save as much as you can afford, as soon as you can afford to do it, and any emergency fund is much better than nothing.

Among those without savings to fall back on, the research shows around one in five will cover the cost from their income – and cut back elsewhere. The rest of us will borrow. One in ten people say they’re forced to dip into an overdraft to afford unexpected expenses, while one in 20 say they use payday loans. Both are horribly expensive, so it’s worth taking the time to find a more affordable alternative.

This can include credit cards or loans, but it’s worth shopping around to ensure you’re using the right one. At the moment, the average credit card rate is 20.29% - the highest on record, but if you have a good credit rating you don’t need to pay anything like this, and you may be able to get a card with a 0% period. The average loan, meanwhile, charges 7.79%, but scouring the market could get you a much better deal. Don’t aim too high though. If a credit card is only available to those with a squeaky clean credit record, do a soft check on a website like moneysavingexpert, to make sure you’re not turned down for a card – which can make other banks less keen to lend to you. You also need to think about how you’ll pay it back. Minimum repayments on a credit card are a guaranteed way to drag the debt on for years or even decades, and ramp up the interest dramatically.

But while a significant minority of people borrow to cover the costs, most won’t turn to a bank: the most common option is to borrow from family and friends. Around one in six people borrow this way – rising to one in five among those under the age of 34. This may feel like the easiest and cheapest option, but it can have horrible emotional and financial repercussions. It means you need to think carefully before asking for help – and before lending friends and family money.

Borrowing issues

Before you ask to borrow, you need to be clear about exactly how much you need, and for how long. That way your family or friends know what you’re asking for. You have to be realistic too: loans between loved ones are far more likely to cause problems if you can’t stick to your repayments, so don’t try to do too much, too quickly.

It’s worth appreciating that this will have an impact on your relationship too. In some cases, family members will lend, trust you to pay it back, and leave you to get on with it. In other cases, for the period that you’re borrowing money, they will have one eye on your finances. Every penny you spend on non-essentials is a penny you’re not repaying, so it can build up some serious friction. If you’re likely to create this dynamic, you’ll need to understand from the outset that your life is going to have to change for the worse until it’s all repaid.

Lending questions

If you’re being approached to lend to family and friends, it’s only natural to want to do everything in your power to help. However, it has to be be affordable. There’s no point stepping in if it’s going to leave you in financial difficulties.

Consider repayments too: if it’s a loan, you should both be clear on what will be repaid, and when. You also need to make a decision about what you’ll do if they can’t make the payments. You’ll either be forced to chase them, which can damage your relationship, or you may need to write the debt off. In some cases, for those who can afford it, the thorny issue of repayment means it’s easier to consider it as a gift rather than a loan.

It also pays to think through what you’ll do if they need to borrow on a regular basis. If you can’t afford to help indefinitely, talk to them. It’s going to be a difficult conversation, but it’s far better for them to know where they stand and be able to make plans than for your help to suddenly dry up.

Money tends to get bound up with relationships, so once you’ve borrowed or lent money, you need to keep communications open. If there are other family members who haven’t needed help, it’s also important to appreciate the potential for this to cause tension with them, and address it before it becomes an issue.

All the emotional complexity involved in borrowing from someone you know means it’s not a cost-free option. It might be all you can do right now, but you need to take steps to ensure it’s not something that ends up damaging vital relationships.

Every form of borrowing comes with some kind of cost, which is why it’s worth doing whatever you can to avoid it, by saving for these unexpected expenses – especially if you drive an old rust bucket with an aversion to Bank Holidays.

Zoopla

Last week’s house price index from Zoopla was decidedly less upbeat than a month earlier. There were still some positives: house prices were still up 1.9% in a year, and in Yorkshire and The Humber, they were up 3%. In the region, sales were also around 10% above the five-year average.

However, locally, demand is down around 15% from the average, and storm clouds are gathering. The surprise rise in core inflation, and subsequent jump in rate expectations have already caused some mortgage companies to push rates up, and more are expected to follow. An awful lot will depend whether rate expectations drop back from here, but if inflation remains stickier than expected, it could mean mortgage rates are higher for longer - which could well dent prices.

SARAH COLESHead of Personal Finance and Podcast Host for Switch Your Money OnHargreaves Lansdown