No one likes to think about falling victim to a major emergency, but we all know that misfortune could strike at any time. It’s important to be prepared, and that means saving up an emergency fund of three to six months of living expenses.
Some people ignore this advice, reasoning that their credit cards will take care of hardships that might pop up. If you’re one of them, be aware there are at least five good reasons you shouldn’t use your credit card as an emergency fund. Take a look:
1. The interest rate is sky high
The most obvious reason you should avoid using a credit card as an emergency fund is the interest you’ll end up paying on your balance. If a really expensive situation arises — say, a blown transmission — and you can’t afford to pay it out of your monthly cash flow, you’ll end up carrying the balance over to the next month. Since most credit cards charge double-digit interest rates, this could get expensive fast.
Keeping a little cash in the bank to use for these types of events is definitely a more cost-effective option.
2. Your issuer could cancel your card
If you keep an extra credit card on-hand for emergencies, but don’t use it otherwise, you probably think you’re making a wise choice. However, if this is your only financial lifeline for dealing with unexpected expenses, you might be in for a nasty surprise.
It’s common for credit card issuers to cancel plastic when a customer isn’t using it regularly. What’s more, no advanced notice of a cancellation is required by the CARD Act of 2009 when it’s due to user inactivity. This means you could be stuck without funds when you need them most.
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3. Credit isn’t always accepted
In a world where swiping a card for a 50-cent pack of gum is commonplace, it’s hard to imagine a circumstance where credit isn’t accepted. But sometimes plastic isn’t welcome, and this could come at a very inconvenient (or scary) moment.
For example, if you’re having an emergency repair done on your home, don’t be surprised if the contractor you’re working with won’t accept a credit card. Many work independently and don’t want to incur the additional costs that come with taking plastic. Consequently, if you don’t have the cash stashed in a bank account to cover the repair, you might be in for trouble.
4. You could ruin your chances of getting credit in the future
Let’s assume for a moment that you are able to use a credit card to cover an expensive emergency. Although you might be breathing a sigh of relief, the consequences of using credit over savings could cause you to suck it right back in.
If you maxed out a credit card (or two) to cope with the catastrophe, you should expect your credit score to drop substantially. This is because you’ve significantly increased your credit utilization ratio, which is the amount you owe on your credit cards compared with their credit limits. As a result, the 30% of your FICO credit score determined by amounts owed will take a big hit. This is fixable, but could make getting credit difficult or very expensive in the future.
5. Eventually, the credit will run out
Life is full of curveballs, and some are very, very sharp. If you’re counting on your credit card to get you out of a jam, there’s no telling how expensive that jam could get. Eventually, your line of credit will run out — at that point, you’ll be out of options for resolving whatever crisis you’re dealing with.
Of course, savings can run out, too. But having a robust emergency fund will buy you some time to explore other alternatives, such as taking out a personal loan or borrowing money from family. Obviously, these are last resorts, but at least they’re options on the table. If you burn through your credit limit and fry your credit score in the process, you’ll have a much tougher time finding additional help.
For these reasons and more, it definitely pays to save. Start putting a little aside today, because you never know what could happen tomorrow.
Life saver image via Shutterstock