Money is tight and you’ve been hit with an unexpected expense. You’re scrambling to figure out a way to pay for it and are considering using your credit card.
While a credit card can be used as a short-term loan option when you don’t have liquid cash available, should you really be using it as an emergency fund? Read on to learn more.
What is an emergency fund?
Life is full of the unexpected. At any moment, you could lose your job or be struck down by an illness. You might find yourself in a car accident or have to immediately fly home if a family member falls ill. While these events aren’t fun to deal with, over the course of your life, they are inevitable.
An emergency fund is a dedicated savings account, typically with three to six months worth of expenses that can help you combat these unexpected costs.
The problem is saving three to six months worth of expenses can be pretty tough to do for the majority of people. According to a survey by the Federal Reserve, only 31 percent of people making less than $40,000 would be able to pay for a $400 emergency expense.
If most people can’t come up with $400 to pay for an emergency, how can they save the equivalent of three to six months worth of expenses?
Why your credit card seems like a better option
Given that so many people can’t afford relatively small emergency expenses, having a credit card with a healthy credit limit can seem like an attractive alternative.
Another reason some people are anti-emergency funds and pro credit cards is that hoarding your money in a savings account is not really financially lucrative.
Most savings accounts have paltry interest rates — many of which aren’t even close to one percent. Having a good chunk of change sitting there earning very little money doesn’t seem like a good idea for some people, especially when you can, potentially, garner higher returns in the stock market.
Should you use your credit card as an emergency fund?
Using your credit card as an alternative to an emergency fund isn’t such a wise idea.
Why? Because using your credit card to pay for emergencies can be a slippery slope into debt. You can have the best intentions and want to pay back your balance in full, but then life gets in the way. Having additional interest on your unexpected balance can create even more problems down the line.
There’s a reason that the emergency fund is a cornerstone of nearly all financial advice. Having liquid cash available to pay for unexpected expenses can help you avoid debt while helping you maintain stability in your finances while everything else seems to be crumbling.
Yes, you aren’t making great returns on your cash and it can seem like it’s “just sitting there.” However, being able to quickly access that cash can make all the difference when you’re dealing with a true emergency.
When using your credit card for emergencies might make sense
If you’re strapped for cash and don’t have money to pay for an emergency, you might have to use your credit card in order to pay for an unexpected expense. You might not have any other options. This is not ideal though and cash is still king when it comes to emergencies.
However, as I mentioned above some people don’t like hoarding cash because:
- It’s tough to save
- It doesn’t offer a great return on your investment
One person I know keeps their emergency fund in easily accessible investment accounts. This way they are getting a higher return on their money, but can easily take money out when an emergency arises. The problem with this method is that the stock market can fluctuate at any given time.
The only instance I think it’s okay to use your credit card as an emergency fund is if you know that you would be able to pay off the balance by the due date. But if you know that you’d be able to come up with the money by the due date, why not save ahead of time?
How to start building an emergency fund
Let’s be real, saving three to six months of expenses can seem daunting. It can seem like a goal that sets you up to fail, making you think, “What’s the point?” Instead of making that your first goal, start saving in chunks.
Let your first goal be to save $500 — which could equate to a small car repair. Then, work up to save $1,000 and so on and so forth.
To get started, set up automatic transfers from your checking to a separate savings account. If you can afford it, start by saving 10 percent of your income. If you are unable to do that, commit to saving one percent. Creating the habit is almost more important than the actual amount you save.
Having a credit card offers a nice buffer and back up plan when emergencies arise. But in reality, a credit card shouldn’t replace an emergency fund. The last thing you want is to deal with an emergency and then deal with the added stress of debt and interest on top of that. If saving is tough, keep your goal small, but stay consistent.
Instead of having a credit card act as your emergency fund, you can use it in addition to your emergency fund. If you play your (credit) cards right, it can even work in your favor.
Let’s say an emergency arises and you put it on a rewards credit card — but then pay it off in full by the due date with your emergency cash reserves — this way, you’ll benefit from the rewards, while also avoiding debt. It can be a win-win situation.
In short, you want to have cash on hand for emergencies and be smart about using your credit card.