Why Are So Many Households Unable to Cover a $400 Unexpected Expense?

Despite a strong economic recovery, about 40 percent of households in 2017 still said they would have trouble paying for a $400 unexpected expense. When households are operating under such a tight budget, building a nest egg for retirement can be challenging. This brief uses data from two Federal Reserve surveys – the Survey of Household Economics and Decisionmaking (SHED) and the Survey of Consumer Finances (SCF) – to understand why so many households say they are unable to cover a relatively small unexpected expense. The discussion proceeds as follows. The first section uncovers a difference between what households say they can afford and what they actually have in their checking/savings accounts. The second section shows that many households, despite having enough in these accounts, may be unable to weather small financial surprises due to unpaid credit card debt. The third section examines whether financial literacy is the problem and finds that it is not. The fourth section uses latent class analysis to examine the characteristics of these vulnerable households. The final section concludes that credit card balances and installment loans (e.g., mortgages, student loans) may be seriously constraining household budgets and are the likely reason that so many middle and higher-income households feel cash-strapped.