If you only knew one thing about credit cards, here’s what personal finance expert Bola Sokunbi would want it to be: Credit cards aren’t your emergency fund.
“A lot of people say that a credit card is an emergency fund, but it really isn’t,” says Sokunbi, founder of Clever Girl Finance. “Credit cards are not your money. I think people forget that.
An emergency fund can be a lifeline in the event of the unexpected, whether it’s covering a short-term expense or helping you get through long periods of financial hardship. Without savings to cover costs in these cases, some people may turn to credit.
“It’s not a good idea unless it’s your last resort, because you’re going to pay it off with high interest,” says Sokunbi. Treating your credit card like a backup plan can have costly consequences and even damage your credit score. Instead, she says, you’re much better off saving as you go – even a little every week – into a savings account that you won’t touch, except in an emergency or business disruption. your income.
Here’s why relying on your credit card in an emergency is risky, and how you can better prepare for unexpected expenses.
Why a credit card isn’t ideal for emergencies
There are many situations in which you could incur an expense that is beyond your usual budget, such as a sudden car repair, for example, or a medical emergency. If you don’t have the money to pay up front, it may seem obvious to charge the cost to your credit card, especially if it has a limit high enough to cover the cost in full.
But like Sokunbi says, your credit limit isn’t your money – it’s borrowed from your issuer. If you rely on a credit card instead of an emergency fund to cover an emergency bill because you can’t afford to pay it out of pocket, it can be a slippery slope to debt balances. at high interest and growing rapidly.
“If you can’t pay your credit card in full [when the balance is due], that’s a really bad idea, ”says Rebecca Montaño, certified financial planner and founder of Sunday Planning, a financial planning company in Denver, Colorado. “Because it could backfire very quickly, even if it wasn’t your intention.” “
Most credit cards charge double-digit interest rates – between 10% and 25% – when you keep a balance. Taking on credit card debt at this rate could cost you hundreds or even thousands of dollars in accrued interest over time, making it even more difficult to pay off over time.
On top of that, any spike in your credit card balance increases your credit usage, or the amount you owe against your credit limit, and could negatively affect your credit score. Without a strong credit rating, you might have a hard time getting approved for debt repayment options like credit cards with balance transfer, as well as a future mortgage or car loan.
How to build an emergency fund
Sokunbi and other experts say an emergency fund – ideally with enough money to cover several months of expenses – is a much better method of covering unexpected costs than a credit card. And the best time to start saving is before an emergency strikes.
Building your emergency fund can give you peace of mind no matter what financial hurdles you face. Whether you need to cover the cost of a new appliance or have a big hospital bill, you’ll be happy to have a cushion.
“It’s a small sacrifice in the meantime, but with the long-term payoff,” Montaño says. You can start with these six steps:
- Learn the benchmarks: Financial experts have different recommendations on how much money to keep in an emergency fund, but three to six months of living expenses is a good rule of thumb.
- Evaluate your expenses: Determine what expenses would be essential for you in an emergency and use them to inform your savings goal. If your budget is tight, consider cutting back on any non-essential expenses, such as take out or subscriptions, and reallocating the remaining money to your emergency fund.
- Start small: Start with a smaller, shorter-term plan and increase your savings over time. For example, putting in $ 20 more each week will equal $ 480 saved in six months. If you find this doable, try increasing it gradually to save more in a faster time.
- Automate the process: Consider automatically sending a portion of your paycheck to your savings each month to help keep you consistent. “I think this way: if it’s not automatic, it’s not done,” Montaño says.
- Review your plan: Whenever your situation or your income changes, reconfigure your savings plan. This adjustment can happen after you find a new job, buy a home, or even retire. And don’t forget to replenish your emergency fund every time you use it.
- Decide on an accountt: Be intentional about where you keep your emergency savings. Typically, a high-yield online savings account can give you easy access to your money when you need it, with the added benefits of small interest payments over time.
Other ways to overcome an emergency
Trying to get through an emergency without saving money can be difficult, but there are alternative resources you can turn to before relying on credit.
Consider contacting your current creditors, lenders, and other financial institutions for assistance; you may be eligible for financial hardship assistance programs that allow you to delay or lengthen payments. Most importantly, stay in close communication with your creditors and lenders to make a plan rather than ignoring or avoiding your bills.
Some credit unions and smaller banks offer emergency loans, which tend to be more affordable than expensive payday loans or high interest credit card debt. Payday loans are notorious for their exorbitant interest rates and can leave you in a worse situation than before, so you should avoid them at all costs. Credit unions also generally offer more flexible qualifying requirements for loans than traditional banks or lenders. Read the terms carefully before taking out these loans as they can also come with high interest rates.
It can also be helpful to research ways to cut your budget – look for subscriptions and recurring charges that you can cut, ways to save money at the grocery store, or unnecessary expenses that could increase your costs – to stretch your cash flow further. .
Some financial planners and nonprofits have been offering free services to people in financial difficulty, especially since the start of the COVID-19 pandemic. They can help you develop a plan to minimize the long-term impact of the difficulties you are facing. If you have close friends or family, you may also want to consider applying for a loan from someone you trust to help you get through an emergency.
If you run out of options, look for these qualities in a map
As with all our credit card notice, our analysis is not influenced by any partnership or advertising relationship.
If you don’t have emergency funds to rely on and you must use a card as a last resort, you can avoid making a bad situation worse by choosing the right credit card to pay for an emergency expense. Here are some qualities you should look for in a credit card to use in an emergency:
- 0% introductory APR: This feature is like a pause button on interest charges for a period of time, typically 12 to 18 months, depending on the card. The US Bank Visa Platinum card has one of the longest introductory periods available today, with 0% interest on new purchases for 21 months from opening the account. If your unexpected expenses don’t need to be paid right away, applying for a 0% interest card can give you a few extra months to pay off an emergency expense before the interest kicks in.
- No annual fee: Pay for emergencies with a card that doesn’t cost you an annual fee to use or keep.
- Regular low APR: Credit cards are notorious for their high interest rates – in fact, Federal Reserve data shows the average APR on all credit card accounts is 14.54%. If you know you’ll need to keep a balance to pay off an expense over time, a card with a lower open APR can help reduce the overall interest you’ll earn.
- Instant approval: It can be helpful to have instant access to a credit card that has not yet arrived in the mail if you are facing an emergency. Some cards give you access to an account through online payments or the ability to log into a digital wallet before you receive the physical card by mail.
- No APR penalty or late fees: You should always prioritize paying your monthly bill on time, but a card with no APR penalty or late fees can help you avoid an increase in your interest rate or unnecessary charges if you ever get a mistake or you cannot make a payment due to Financial Hardship.
Only consider putting an emergency expense on a credit card if it’s your last resort. In the long run, taking on high-interest debt to deal with an emergency can put you in a worse financial position over time.
“Once interest starts to accrue on a credit card, it can be very slippery,” says Sokunbi. “What people don’t realize is that it’s never the primary balance that keeps you stuck. It’s the fact that interest sometimes builds up on a daily, weekly, monthly basis, and over time this can cause the debt you owe to far exceed what you have borrowed.
If you don’t have an emergency fund, start creating one now to help you get through future financial difficulties without going into debt. Contributing even a few dollars a week to a savings account can make all the difference down the road and help you reach the other side on a more solid footing.