From a car that breaks down at the worst possible time to a furnace that goes out in the winter, everyone faces unexpected expenses at some point. Many people reach for their credit card to pay for emergencies, whether it be because they cannot afford to pay the bill upfront or because they don’t want the lump sum coming out of their bank account. However, financial advisors don’t recommend financing unexpected costs on a credit card if you can avoid it. Instead, they urge all Americans to strive to build their savings account balance to an amount that would cover living expenses for at least three months.
If saving that amount of money doesn’t seem realistic for you right now, consider reworking your budget to determine if you can cut back on some expenses or figure out how you can save more in certain areas. While that might sound easier said than done, it will help get you to a position where you don’t need to charge emergencies on credit. Here we highlight the risks of using a credit card as a long-term strategy to pay for emergencies – and why you may want to reconsider doing so.
Buying on Credit has the Same Implications as a Loan
When you borrow money in the form of a loan, you typically pay back interest in addition to the amount you borrowed. Similarly, you will owe interest to your credit card issuer if you do not pay the card balance in full every month. Plus, credit card interest is often charged at double-digit rates. Those added interest charges can make it hard for you to repay your balance in full, especially since they will continue to accumulate every month you carry a balance.
By using your own savings to pay for emergencies, you can help avoid getting into serious credit card debt. Significant credit card debt can have a negative impact on your credit score and could prevent you from borrowing money when you need it down the road. When you’re looking to buy a house or purchase a vehicle you don’t want your credit card balance coming back to haunt you. Sure, you may have to rebuild your savings after using it to fund an emergency, but you’ll avoid interest charges and help prevent damage to your credit history.
In addition to the obvious risk of getting into a cycle of debt, here are some other risks to consider with using a credit card to pay for emergencies:
• Card inactivity. If you only plan to use the credit card for emergencies, the issuer may assume the account is dormant and close it or charge you for non-activity. You could find yourself in a challenging situation if you were counting on credit to be available to you in an emergency only to have the card declined instead.
• Credit card limits. Maybe you have heard the saying that good or bad things happen in threes. Although there is no scientific proof to back that up, you do need to consider what would happen if you had two or three unplanned expenses occur close together. You could soon find yourself over the credit limit and paying an extra fee for that as well.
• Not all merchants accept credit cards. This might seem like a foreign concept, but some smaller companies do not take credit cards because the swipe fees are unaffordable for them. One time you might run into this situation is when you hire a small business contractor for an unexpected home repair who only accepts cash or checks.
• Monthly credit card payments could otherwise be put into savings. Having an ongoing balance on your credit card means your extra funds must go towards paying it off rather than building your own cash emergency fund.
• Credit cards can make you lazy. You may be less likely to look for other solutions in an emergency if you know that you have a credit card available. This is because for some people, using a credit card doesn’t feel like spending “real” money. On the other hand, if you know the money is coming out of your savings account, you may be more apt to hunt around for the best deal, see if you can fix something yourself, or read reviews to ensure you’re choosing a reputable company to do business with.
When Life Happens, Make It a Point to Repay Credit Card Debt Quickly
Whenever possible, it’s a good idea to avoid putting emergency expenses on a credit card. However, sometimes things happen that you just have no way of preparing for in advance. This can be especially discouraging when you are making progress towards your financial goals. If that happens, just let the situation motivate you to repay your credit card debt as soon as possible. Once your credit balance is paid off, you can get back to putting money in your emergency fund on a regular basis.
There are many ways to help make saving more fun and less of a burden. If you need help determining which type of savings account is the right fit for your specific financial goals, contact us today!