Life has a way of happening, right? Sometimes, even with your perfectly balanced, meticulously detailed budget, something can derail your plans. An unexpected emergency, reduced hours or commission, a medical shows up 18 months after the fact, etc. I’ve always advised my clients to have access to emergency funds, and I recommend the same to you. Here, the discussion revolves around what to do if your emergency fund either doesn’t cover it, or you don’t want to fully deplete it. If something needs to be left out, where should you start? Let’s take a look.
A guy I used to follow would tell the story that he would put the names of everyone he owed money to into a hat. Each month, he would draw 3 names. If your name wasn’t drawn, you wouldn’t be paid. He added that if any collectors started harassing him on the phone, he threatened to take their name out of the hat. He always told this story in a way to draw laughs from the crowd, and it worked. Does it work as a financial plan? I wouldn’t recommend it!
I’m going to assume you have the following types of monthly bills: mortgage/rent, utilities, student loans, 1 or 2 car loans, cell phone service, unsecured credit cards, and a personal loan. This list should include almost everything that falls under “monthly bill” that people have. I’ll also include a guide for how to place the priority on something that isn’t on this list. I realize that I don’t have food and gas on this list, but I don’t label them as “bills” because someone isn’t going to call you if those two items don’t get paid. I am referring to “bills” as something that you pay monthly and, if you don’t pay, someone will notice and attempt to contact you about it.
Common misconceptions/myths about not paying your bills
Before I get to my recommended list, I wanted to share some common myths about this topic. These are important because they make a huge difference in your priorities if you understand them and plan accordingly. For example, many people think their power will get turned off if they are a day late. If you know that isn’t true, would you prioritize paying the electricity bill over food if you knew you had more time? So, what are the myths?
1) Missing a payment by one day kills your credit score. This is false. Your credit score isn’t affected until you hit the 30-day late mark. If you look at a copy of your credit report, you’ll see the numbers “30, 60, 90” on there. Those numbers mean days late, and those are the numbers that impact your score. Being 29 days late doesn’t affect your credit. The worst that can happen for being between 1-29 days late is a late payment fee. Also, late payments on utility bills only affect your credit score if they pursue legal action against you(like a collection). Your monthly utility payments are not in your credit report.
2) Your electricity will immediately be shut off if you are late. I mentioned this earlier, and it’s an important detail to know. It will take a minimum of two months(in standard cases) before the threat of shutting off your power or other utility. Now, if you are a repeat offender, it might be different. If it’s your first time, you’re safe before the two-month mark. Even then, you’ll probably still have time. If you run into that scenario, you’ll know when your power is getting shut off. The power company will be glad to inform you.
3) If you are late on a car payment, they will repossess your car immediately. One or two months won’t lead to a repo of your car. It will most likely be six months or longer. This may surprise you, but banks don’t want to repossess your car. They don’t have agents sitting in the shadows counting down to a late payment, hoping to take your car right away. Banks want you to pay. If you start running late, they’ll work with you on a plan long before repossession is the answer.
4) If you are late on your mortgage, you will be evicted quickly. This is absolutely false. I’m certainly not encouraging you to not pay your house note, but the process of evicting somebody is cumbersome. Some states make it near impossible to evict people. My point is that if you are late by one or two months it doesn’t mean you need to start clearing the air with all your relatives. You have some time. Again, banks don’t want to evict you and they’ll work with you long before it reaches that point.
What you should never exclude
1) Any federal debt doesn’t need to be missed, like a student loan or a tax bill. Leaving these unpaid for too long will get you into big trouble. Do your best to get those paid.
2) Utilities. I realize some people may not include utilities like electricity/water/phone on this list, but they get cut off much sooner than anything else on the list I’m working from if you don’t pay them. It could take 6 months to get your car repossessed, but only 2 months to lose electricity.
What is the best order to use to exclude bills?
1) Unsecured credit cards or personal loans. These should be excluded first because there is no collateral tied to them—meaning nothing will get repossessed if you don’t pay. The worst that can happen is some late fees and hits to your credit score. Those are certainly bad things, but if a payment to someone must be missed, this is where to start.
2) Cell phone service. For the most part, the worst that could happen here is a late fee on your bill. It won’t affect your credit unless the company has to file a claim against you. If you miss a payment or two, you’ll still most likely have service and you’ll only owe some extra money for late fees.
3) Secured credit cards. These are credit cards that are linked to a savings account. The cash is used as the collateral. If you miss payments on these and fall behind, the bank will eventually close your credit card and your savings account and collect the cash. This will hurt your credit score and your ability to do additional business with the bank(and likely other banks too).
4) Equipment loan(automobile, piece of machinery for a business, etc.). After missing a few of these payments, the bank will repossess the equipment being used as collateral. More than likely, you need this equipment to either get to work to make the money to pay the loan, or to generate income for your business. It’s not good if you take out an income source while you’re struggling to make payments as it is. The only way I would consider shifting this around would be if you were 100% certain you’d only miss one payment and could make it up quickly. If that’s the case, and the payment is much higher for this, it might make sense to miss it. However, that is case-by-case, and you shouldn’t use this blog alone to make the decision since I don’t know your situation.
5) Mortgage/rent, HELOCs. This is another one where it’s possible to adjust based on your situation. For most people, I’d put it last simply because you don’t want to risk being evicted. Eviction would likely destroy your chances of continuing to generate income and get your other debts paid. It would most likely take at least 6 months from your first missed payment for eviction to be a serious threat. I included HELOCs here because those are considered a mortgage on your house. That means if you pay your mortgage but don’t pay your HELOC, you can still run into loads of legal trouble concerning your house.
What if I am a small business owner?
I would keep the thought process the same for business owners. If a debt is unsecured, let that one slide first. Then, go in order of the least important collateral to the most important. Lastly, don’t miss your building payments if you can help it. If you lease your building, the owner may evict you sooner than 6 months, but that depends on a number of variables that I will not speak on here. Also, be sure your employees get paid first. If you are choosing between missing all your payments or not paying your employees, always pay your employees. If you don’t, they won’t show up to work tomorrow and you’ll face legal trouble. That would essentially kill your ability to make money.
Obviously, we all hope to never face the choice of who doesn’t get paid. Life happens, and things don’t always work out the way we expect. I hope this guide has helped you in the event you face these types of decisions. A good companion to this post is where to get funds in the event of an emergency. Be sure to check it out.
