Instead of putting money in an emergency fund, many people use credit cards for emergencies. In some cases, the use of credit cards as an emergency source of funding is only for smaller, short term, issues, such as car repairs. However, using credit cards for emergencies, no matter their size, can lead to bigger problems down the road.
One of the biggest traps is that of easy repayment. Using a credit card in an emergency can provide a somewhat inaccurate view of the financial situation. This is because, instead of having to pay back the entire amount at once, you only have to make a minimum payment each month. So, if you put $1,000 on your credit card to pay for an emergency car repair, you may only have to pay $25 to $30 a month. If you only pay the minimum, though, it will take more than three years — and plenty of interest fees — to repay the loan. And that’s only if you don’t put anything else on the card in the mean time. If you had saved up in an emergency fund, you would have been earning interest (albeit a small amount) on the money in your account, rather than paying it.
Additionally, you wouldn’t have to worry about making sure you can make your payment each month, since you would have used money already saved up. While you will want to replenish your emergency fund, if your financial situation is difficult, you won’t be in danger of default on a credit card loan.
More from GFC, Below
Even if you do what you can to pay off the emergency expenditure in three to five months, you could still be developing a dangerous habit. It is one thing to have a financial plan that involves earning reward points on your credit card and then paying off the balance each month. It is quite another, though, to use a credit card without regard to budget, and get in the habit of turning to credit when you are in trouble. This type of habit can eventually lead into a pile up of credit card debt that is hard to move beyond as balances are carried and interest charges add up. Even if you are used to using a credit card as part of your monthly financial plan, and paying it off, you can incorporate that.
Set money aside in an emergency fund. If you have to charge extra, beyond your budget, for an unexpected expense, you can use money from your emergency fund to help pay off the balance at the end of the month. The important thing is to avoid paying interest when possible. As a result, having a true emergency fund can help you prepare for the unexpected, without having to rely too much on credit cards.
It is true that credit cards can be very useful in some situations to help build your credit. They are easy to use, and provide you with immediate access to funds that may not be available when you have a high yield savings account. When you are stuck, a credit card can help you out of a jam. However, it is still a good idea to have an emergency fund so that you can pay off the amount charged before it accrues interest. That way, building up debt is not your only option in an emergency situation.