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The Best Insurance Against Credit Card Debt? Savings.

March 2, 2015
Credit Card Basics, Credit Cards
The Best Insurance Against Credit Card Debt? Savings.
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Credit card debt is generally the most expensive form of financing. That’s why the Nerds urge you to pay your balance in full each month. But sometimes, you may end up charging more or making less than planned. Maybe your car needs a major repair or your job changes. When that happens, the best insurance you can have against credit card debt and all its costs is a savings account.

Emergencies will happen — be prepared

The number of people who say they have enough emergency savings is going down, falling to 64% in a report last year, from 71% in 2010, according to the Annual National Survey Assessing Household Savings. Those with lower incomes are least likely to have enough for unforeseen expenses.

Emergencies are almost inevitable, so having an adequate emergency fund is key. The amount you should save will depend on your lifestyle, but enough to cover three to six months of expenses is advisable.

» MORE: How to pay off debt

Your credit card isn’t an emergency fund

You can certainly put emergency expenses on your credit card to earn rewards and for purchase and warranty protections. But  you need to pay them off by the end of the month to avoid paying interest.

Credit cards have very high interest rates and relatively low minimum payments. If you only pay the minimum, you could be paying off today’s emergency years from now.

Bear in mind that not all of life’s emergencies will take plastic. For instance, if you lose your job, you can probably put a lot of your expenses on credit. But you may not be able to pay for your rent or mortgage that way.

Plus, if an emergency takes up a large part of your credit limit, your credit score may suffer. The ratio of your debt to your limit, known as the credit utilization ratio, shouldn’t exceed 30% if you want to maintain a healthy score. Don’t allow an emergency to derail your finances and your credit.

Start saving for future emergencies today

Three to six months of expenses may seem like a lot of money to save up, but don’t get overwhelmed. Start small with automatic withdrawals from your checking to your savings account coinciding with payday.

If there’s truly no room in your budget to save anything, use these tips to make more and spend less. Put any additional cash into your emergency fund — ideally a high-yield savings account. They pay almost nothing in interest, but you’ll want this money readily available so you can deal with a crisis as it comes.

Don’t forget occasional windfalls like tax refunds, rebates, raises, cash gifts or inheritances. Put these into your emergency fund to supercharge your savings and be prepared sooner for peace of mind.

Bottom line: Avoid getting into credit card debt by having enough of an emergency fund to cover unexpected expenses.  Build your emergency fund with consistent saving and any windfalls that come your way.

Erin El Issa is a staff writer covering personal finance for NerdWallet. Follow her on Twitter @Erin_Lindsay17 and on Google+.

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