Just the other day, we brought our car in for an oil change and got a call back 45 minutes later saying "Your brakes need to be replaced, pronto." And $500 later, we had new brakes, but a much lower savings account balance to go along with them.
I'm thankful we had that $500 available in our emergency fund, though. Had that money not been there, we would've had no choice but to charge that auto repair on one of our credit cards and pay it off over time, since failing brakes aren't exactly an issue that can wait.
Unfortunately, some people don't have a lot of money in savings and need to rely on credit cards when unplanned bills arise. To be clear, this is a reasonable route to take when you're stuck in that situation out of the blue. If you come home to find that your heating system has failed, and it's the middle of winter, then you need to get that fixed right away. If you don't have the $1,000 it will cost available to you in savings, then charging that expense on a credit card and paying it off as quickly as you can may be your best bet.
But generally speaking, your credit card should not serve as a substitute for an emergency fund. Here's why.
1. You don't want to get stuck paying interest
When you charge expenses on a credit card and don't pay your balance in full by the time it's due, you automatically sign up to pay more for those expenses in the form of interest charges. Going back to our example, a $1,000 heating repair bill could end up costing you $1,100 or $1,200 if you charge it and it takes you a while to pay your credit card off. But if you have that money available in savings, you can pay the $1,000 and call it a day.
2. You don't want to damage your credit score
If you end up having to carry a small credit card balance relative to your total spending limit across your various cards, your credit score may not suffer due to it. But if you keep having to charge emergency expenses on your credit cards to the point where your balance keeps climbing, your credit score could take a hit.
Your credit utilization ratio is a big factor that goes into calculating your credit score. That ratio measures how much of your total credit limit you're using at once. If that ratio stays at or under 30%, you should be in good shape. Beyond that threshold, credit score damage can occur.
Going back to our example, if you're forced to charge a $1,000 heating repair on a credit card, but you don't have an existing balance on top of that and your total credit limit is $10,000, your credit score shouldn't suffer. But if you already owe $3,000 on your credit cards and add to that total by $1,000, you'll be at 40% utilization, which could cause your credit score to drop.
Don't rely too heavily on credit cards
You may run into a situation where you have to charge emergencies on a credit card in a pinch. What you shouldn't do is point to your credit cards as a reason not to build an emergency fund.
Ideally, you should have enough money in the bank to cover three to six months of living expenses. You may not get to that sum right away, but if you work toward it over time, you'll buy yourself a nice amount of protection against the many unpleasant financial surprises that could come your way.
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November 20, 2021 at 07:32PM
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Why Credit Cards Should Not Serve as Your Emergency Fund - Motley Fool
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