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Should you use a credit card as your emergency fund?

Summary

Credit cards come with myriad benefits, such as rewards and consumer protections, and can be a financial lifeline on rare occasions.

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Credit cards come with myriad benefits for consumers, from the rewards they offer to consumer protections such as travel insurance and guaranteed returns, and on rare occasions, that credit cushion also can be a financial lifeline.

But should you use your credit card as your emergency fund?

We talked to people who’ve relied on their credit cards for temporary loans to get them through a tight spot. Sometimes it worked. Sometimes their problems only grew worse.

Using the term ’emergency’ a little too loosely

Thirty-two-year-old Andrew Ellis of Tampa, Florida, found out about the risks of using plastic for emergencies firsthand in 2017. It all started when he read a dated blog post on a popular website titled “Springy Debt Instead of a Cash Cushion.”

This piece argued that not everyone needs a cash cushion for emergencies, and that “it is a huge waste of money to keep money in the bank earning no interest, while paying higher interest on debts.” Instead, the popular blogger suggested using a credit card in lieu of a traditional emergency fund – advice Ellis took to heart.

Since Ellis and his wife were paying off credit card debt at the time, they decided it made no sense to keep cash in the bank earning pitiful returns. Instead, they decided to continue paying down debt and use a credit card for emergencies.

Unfortunately, the family didn’t set aside a card specifically for emergencies. They kept spending on all their cards – even the ones with balances they were trying to pay down.

They also used the term “emergency” a little too loosely, leading them to use credit cards for things such as unplanned grocery trips to satisfy random food cravings. This led to the family accumulating around $3,500 in additional debt over the four months they were using this strategy.

“We went from less than $1,300 of total credit card debt to just under $4,800 and added almost a year to our projected debt payoff at our current rate of payment,” he said.

High-interest debt can turn an emergency into a catastrophe  

Debt is bad enough, but high-interest debt can be catastrophic. And that leads us to yet another problem if you use credit for emergencies: If you have an actual financial emergency, you will pay interest when you carry a balance from month to month.

Since the average interest rate on credit cards is now over 17 percent, this is one of the most expensive loans you can get.

And, this is where consumers get it all wrong, says San Diego financial adviser Jon Luskin.

Another reason you shouldn’t use a credit card as an emergency fund has to do with security and the fact that credit cards offer very little of it.

See related: First-time cardholder? Avoid these 5 common credit card mistakes

Financial adviser Benjamin Brandt, who hosts “Retirement Starts Today Radio,” says if you need to tap into your credit line due to an emergency job loss, relying on a credit card would be the worst possible scenario.

“Our investments exist to make us money long term, but our emergency fund exists to ensure our long-term investments can remain invested long-term.”

“You will immediately begin accruing interest at the exact time when you are least able to pay it,” he said. You wouldn’t have this problem with cash reserves.

This is part of the reason Brandt suggests overlooking the fact that your emergency fund may not be earning a lot of interest and instead viewing it as an insurance policy – not an investment.

“Our investments exist to make us money long term, but our emergency fund exists to ensure our long-term investments can remain invested long-term,” he says.

Your access to credit is not a sure thing

A final reason not to use a credit card for emergencies is the fact that you are not in charge of what happens to your line of credit.

New York-based financial planner Kaya Ladejobi of Earn Into Wealth says that credit cards are not reliable.

“The creditor or institution can change their terms at any time to reduce your limit or cancel your limit,” said Ladejobi.

What if your crisis coincides with an economic downturn? In that case, banks may be more likely to lower available credit limits or increase their fees. If that were to happen, your credit card emergency fund could suddenly become less robust or helpful than you thought.

The right way to build an emergency fund

If you shouldn’t rely on credit for emergencies, how should you prepare for them? The experts we spoke to all agreed that building a cash emergency fund with at least three to six months of expenses is the way to go.

And you don’t have to keep your cash in a high-interest checking account that is earning a pittance.

For example, you could put part of your emergency fund into a Roth IRA that invests your money into low cost index funds or other investments.

While Roth IRA accounts are technically for retirement, you can withdraw contributions (not earnings) at any time without paying any penalties or taxes.

According to Luskin, you could also consider putting your emergency fund into a certificate of deposit (CD). Not only could this strategy help you secure a higher rate of return than you would get with a bank account, but it would also add a layer between you and your money so you wouldn’t be tempted to spend it unnecessarily.

You would have to pay a penalty to access your CD before it comes due, however, and this penalty could amount to several months of interest depending on the original CD term you signed up for.

But even if you stuck with a regular high-interest savings account, you would be in good shape. The traditional “emergency fund” is a mainstay of responsible personal finance. By keeping several months of expenses in an easily accessible account, experts say, you can protect yourself against job loss, a loss in income, or unexpected expenses like medical bills or a surprise home repair bill.

Most importantly, you can protect yourself against the one thing a credit card emergency fund will most likely cause – debt.

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