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 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 when the unexpected happens, whether it’s covering a short-term expense or helping you through long periods of financial hardship. Without savings to cover the costs in these cases, some people may turn to credit.
“It’s not a good idea unless it’s your last resort because you’ll pay it off with high interest,” Sokunbi says. Treating your credit card as a backup plan can have costly consequences and even hurt your credit score. Instead, she says, you’re much better off saving as you go — even just a little each week — into a savings account that you won’t touch unless there’s a emergency or disruption to your income.
Here’s why it’s risky to rely on your credit card in an emergency and how you can better prepare for unexpected expenses.
Why a credit card is not ideal for emergencies
There are many situations in which you might incur an expense outside of your usual budget – a sudden car repair, for example, or a medical emergency. If you don’t have the cash to pay upfront, it might seem like a no-brainer to charge the cost to your credit card, especially if it has a high enough limit to cover the entire cost.
But as Sokunbi says, your credit limit isn’t your money – it’s borrowed from your issuer. If you’re relying 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. high interest and fast growing.
“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 on you very quickly, even if that’s not your intention.”
Most credit cards charge double-digit interest rates — between 10% and 25% — when you carry a balance. Going into debt on a credit card at this rate could potentially cause you to lose hundreds or even thousands of dollars in accrued interest over time, making it even more difficult to pay it back over time.
On top of that, any spike in your credit card balance increases your credit utilization, or the amount you owe against your credit limit, and could negatively affect your credit score. Without a strong credit score, you may have difficulty getting approved for debt repayment options like balance transfer credit cards, 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 obstacles you face. Whether you need to cover the cost of a new appliance or have a hefty hospital bill, you’ll be glad you have a cushion.
“It’s a small sacrifice in the meantime, but with a long-term reward,” says Montaño. You can start with these six steps:
- Learn the cues: Financial experts have different recommendations on how much money to keep in an emergency fund, but three to six months’ worth of living expenses is a good rule of thumb.
- Evaluate your expenses: Figure out what expenses would be essential to you in an emergency and use them to set your savings goal. If your budget is tight, consider cutting non-essential expenses — such as takeout or memberships — and reallocating any remaining money to your emergency fund.
- Start small: Start with a smaller, short-term plan and grow your savings over time. For example, putting in $20 more each week is equivalent to saving $480 in six months. If you find it doable, try increasing it gradually to save more faster.
- Automate the process: Consider automatically sending a portion of your paycheck to your savings each month to help you stay consistent. “I think of it this way: if it’s not automatic, it doesn’t happen,” says Montaño.
- Review your plan: Whenever your situation or income changes, reconfigure your savings plan. This adjustment can happen after finding a new job, buying a house, or even retiring. And don’t forget to replenish your emergency fund each time you use it.
- Choose 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 get through an emergency
Trying to deal with an emergency without saving 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 hardship assistance plans that allow you to delay or spread out payments. Most importantly, stay in close communication with your creditors and lenders to come up with a plan rather than ignoring or avoiding your bills.
Some credit unions and small 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 worse off than before, so you should avoid them at all costs. Credit unions also generally offer more flexible qualification requirements for loans than banks or traditional lenders. Read the terms carefully before taking out these loans, as they can also carry high interest rates.
It can also be useful to research ways to reduce your budget – look for subscriptions and recurring charges that you can reduce, ways to save on groceries, or unnecessary expenses that could increase your costs – to further stretch your cash flow. .
Some financial planners and nonprofits are offering free services to people in financial difficulty, especially since the onset of the COVID-19 pandemic. They can help you develop a plan to minimize the long-term impact of any difficulties you encounter. If you have close friends or family, you might also consider asking someone you trust for a loan to help you get to the other side of an emergency.
If you are out of options, look for these qualities in a card
As with all of our credit card reviewsour analysis is not influenced by any advertising partnership or relationship.
If you don’t have an emergency fund to fall back on and need to 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 an emergency credit card:
- Launch APR at 0%: This feature is like a pause button on interest charges for a period of time, usually 12 to 18 months, depending on the card. US bank visa® Platinum Card has one of the longest introductory periods available today, with 0% interest on new purchases and balance transfers for 20 billing cycles, then a variable APR of 14.49% at 24.49%. If your unexpected expenses don’t need to be paid immediately, 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 an emergency with a card that doesn’t cost you an annual fee to use or maintain.
- Low Regular 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 carry over a balance to pay for an expense over time, a card with a lower current APR can help lower the overall interest you’ll accrue.
- Instant Approval: It can be helpful to have instant access to a credit card that hasn’t arrived in the mail yet if you’re dealing with an emergency. Some cards give you access to your account through online payments or the ability to log in to a digital wallet before you receive the physical card in the mail.
- No APR penalty or late fees: You should always prioritize paying your monthly bill on time, but a card with no APR penalties or late fees can help you avoid an increase in your interest rate or unnecessary fees if you ever misstep or 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 term, taking on high-interest debt to cover an emergency can put you in a more difficult financial situation over time.
“Once interest starts accumulating on a credit card, it can be a very slippery slope,” says Sokunbi. “What people don’t realize is that it’s never the main balance that keeps you stuck. It’s the fact that interest sometimes accrues on a daily, weekly, monthly basis, and this can, over time, result in the debt you owe far exceeding what you borrowed.
If you don’t have an emergency fund, start building one now to help you weather future financial challenges without going into debt. Contributing even a few dollars a week to a savings account can make all the difference later on and help you reach the other side on a stronger footing.