If you knew just one thing about credit cards, personal finance expert Bola Sokunbi would love it: credit cards are not 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. âCredit cards are not your money. I think people forget that. “
An emergency fund can be a lifeline when the unexpected happens – from covering short-term expenses to supporting extended financial emergencies. With no savings to cover the cost in these cases, some people may turn to credit.
“It’s not a good idea unless it’s your last resort because you’ll be paying high interest for it,” says Sokunbi. Treating your credit card like a backup plan can have costly consequences and even affect your creditworthiness. Instead, she says, it’s much better to save over time – even just a little each week – into a savings account that you don’t touch unless there’s an emergency or interruption to your income.
Here’s why it is risky to rely on your credit card in an emergency 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 can cover expenses outside of your usual budget – such as a sudden car repair or a medical emergency. If you don’t have the money to prepay, it can seem obvious to put the cost on your credit card, especially if the limit is high enough to cover the cost in full.
But as 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 pay an emergency bill because you can’t afford to pay it out of your pocket, it can be a slippery descent to fast-growing, high-yielding debt balances.
âWhen you can’t pay your credit card in full [when the balance is due], it’s a really bad idea, “says Rebecca MontaÃ±o, certified financial planner and founder of Sunday planning, a financial planning company based in Denver, Colorado. “Because it could backfire very quickly, even if it is not your intention.”
Most credit cards charge double-digit interest rates – between 10 and 25% – when you have a balance. Taking on credit card debt at this rate could potentially set you back hundreds or even thousands of dollars in accrued interest over time, making repayments even more difficult over time.
Additionally, any increase in your credit card balance increases your credit usage, or the amount you owe relative to your credit limit, and can have a negative impact on your credit score. Without a solid credit score, you may have difficulty getting approved for debt repayment options such as credit transfer credit cards, as well as a future mortgage or car loan.
How to build an emergency fund
Sokunbi and other experts say that an emergency fund – ideally with enough cash to cover several months’ worth of expenses – is a much better way to cover unexpected expenses than a credit card. And the best time to start saving is before an emergency occurs.
Building your emergency fund can give you peace of mind, no matter what financial obstacles you face. Whether you’re covering the cost of a new home appliance or facing a hefty hospital bill, you’ll be glad to have a pillow.
“In the meantime, it’s a small sacrifice, but with the long-term reward,” says MontaÃ±o. You can start with these six steps:
- Learn the benchmarks: Financial experts have different recommendations on how much cash to keep in an emergency fund, but the cost of living of three to six months is a good rule of thumb.
- Evaluate your expenses: Find out which expenses would be important to you in an emergency and use them as the basis for your savings goal. If your budget is tight, consider cutting any non-essential expenses – such as takeaway or subscriptions – and reallocating the leftover money to your emergency fund.
- Start small: Start with a smaller, shorter-term plan and grow your savings over time. For example, if you save an additional $ 20 every week, you will save $ 480 in six months. If you find this doable, try increasing it gradually to save more in less time.
- Automate the process: Consider automatically sending a portion of your paycheck to your savings every month to help you stay consistent. âI imagine it this way: If it doesn’t work automatically, it won’t be done,â says MontaÃ±o.
- Reconsider your plan: If your living circumstances or your income change, reconfigure your savings plan. This adjustment can happen after you’ve got a new job, bought a home, or even retired. And don’t forget to replenish your emergency fund when you use it.
- Decide on an accountt: Think about where to keep your emergency savings. In general, a high yielding online savings account provides easy access to your money when you need it, with the added benefit of small interest payments over time.
Other ways to weather an emergency
Trying to weather an emergency with no savings can be a challenge, but there are alternative resources that you can turn to before relying on credit.
Consider seeking help from your current creditors, lenders, and other financial institutions; You may be eligible for financial hardship allowance plans that allow you to delay or extend payments. Most importantly, instead of ignoring or avoiding your bills, you keep in close contact with your creditors and lenders to come up with a plan.
Some credit unions and smaller banks offer emergency loans, which are usually cheaper than expensive payday loans or high-interest credit card debt. Payday loans are known for their outrageous interest rates and can make you look worse off than before, so you should avoid them at all costs. Credit unions also typically offer more flexible loan qualification requirements 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 help to look for ways to cut your budget – look for recurring subscriptions and fees to cut, ways to save on grocery stores, or unnecessary expenses that could add to your costs – yours To further increase cash flow.
Some financial planners and nonprofits have been offering free services to people in financial distress, especially since the COVID-19 pandemic began. They can help you create a plan to minimize the long-term effects of any difficulties you face. If you have close friends or family, you can also ask someone you trust for a loan to help you reach the other side in an emergency.
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If you don’t have an emergency fund and have to use a card as a last resort, avoiding a dire situation can be by choosing the right credit card to pay for an emergency expense. Here are some features to look out for in an emergency credit card:
- 0% introductory APR: This function is like a pause button for interest charges for a longer period of time, usually 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 account opening. If your unexpected expenses don’t need to be paid immediately, applying for a 0% Interest Card can give you an extra few months to repay an emergency expense before interest pays.
- No annual fee: Pay for an emergency with a card that doesn’t cost an annual fee to use or hold.
- Low regular APR: Credit cards are known for their high interest rates – in fact Federal Reserve data shows that the average APR across all credit card accounts is 14.54%. If you know you will need to hold funds to pay an expense over time, a card with a lower APR can help reduce the total interest you incur.
- Immediate approval: It can be helpful to have instant access to a credit card that hasn’t made it in the mail when you’re dealing with an emergency. Some cards give you account access through online payments or the ability to connect to a digital wallet before you receive the physical card in the mail.
- No APR penalty or late fee: You should always prioritize paying your monthly bill on time, but a card with no penalty interest or late fees can help you avoid increasing your interest rate or avoiding unnecessary fees if you ever slip up or make a payment due to financial difficulties.
Only consider putting an emergency expense on a credit card if that’s your last resort. In the long run, borrowing high-yield debt to cover an emergency can place you in worse financial condition over time.
“Once interest rates start to rise on a credit card, it can be a very slippery descent,” says Sokunbi. âWhat people don’t realize is that it’s never the most important balance that holds you in place. It is the fact that sometimes the interest increases daily, weekly or monthly, and over time this can result in the debt you owe well in excess of the amount you borrowed. “
If you don’t have an emergency fund, start one now so you can weather any financial hardship without going into debt in the future. Depositing just a few dollars a week into a savings account can help you make the difference later and help you reach the other side on a more solid basis.