Your Credit Card is Not an Emergency Fund

Posted: 05 Aug 2010 03:59 AM PDT

You know that you need an emergency fund. An emergency fund can help keep you solvent when unexpected financial catastrophes arise. Many people, though, forget that a good emergency fund is one that you build up over time, so that you have a reserve of cash. A credit card does not fall into this category, no matter how much you would like it to. The simple fact of the matter is that a credit card is not an emergency fund, and it shouldn’t be considered as such.

Why Credit Cards Make Bad Emergency Funds

The whole point of having an emergency fund is so that you can tap into your resources without needing to resort to using debt. Using a credit card as an emergency fund defeats that purpose. Instead, you end up with more debt when you use a credit card to fund your emergencies. The interest you pay on the credit card is also quite high. Using a credit card as an emergency fund can actually make matters worse by the time you pay interest back on top of the amount used for the emergency. When you have an emergency fund in an interest bearing account, your money is working for you, rather than against you.

Another issue is that you will have to make monthly payments. If your emergency is big enough, even the minimum payment on the credit card can be a financial burden — especially since you will have to start making payments immediately. With a properly set up emergency fund, you can begin rebuilding after the emergency has passed. You don’t have to worry as much about paying off your emergency while you still may be in a difficult position.

Finally, using a credit card as an emergency fund confirms you in habits that are not likely to contribute to your financial health. Such an arrangement gets you into the habit of turning to your credit card frequently to solve problems. This can develop into a habit that can put you further in debt.

Credit Card for Emergencies vs. Credit Card as Emergency Fund

In some cases, having a credit card for immediate emergencies makes sense. You might be stuck out in the middle of nowhere, needing your car towed (this has actually happened to me). In such situations, a credit card can be quite helpful, since you may not be able to get to an ATM (or want to pay the fees if you could find one). The flexibility of a credit card, along with the purchase protections that can come with it, can be comforting and useful when you are away from home in an emergency situation.

However, using your credit card for an emergency is not the same as relying on it as your emergency fund. If you use a credit card in a tough situation, you should pay it off as quickly as possible, reducing the balance so that you limit the interest you pay. You can use money from your emergency fund to help pay down the credit card, and then make a plan to rebuild the fund. This way, you are avoiding the debt trap by using your emergency stash to pay off emergency use of your credit card.