There are situations where using a credit card as your emergency fund is probably the right decision.
Yes! If you’re already in credit card debt or if you are a savvy investor that manages very high returns then credit could be the right emergency plan for you.
Let me make the argument for these two people.
Then if you’re convinced, I’ll look at some of the details of actually making this very untraditional approach work.
#1. Already In Credit Card Debt
A person who is already in credit card debt should almost certainly not have an emergency fund.
Any extra cash they have should go straight towards paying off the credit card debt.
Rob Berger from Dough Roller agrees that those with existing credit card debt should not have an emergency fund for as long as they hold that debt.
Because that credit card debt is accumulating interest at rates usually above 20%. And an emergency fund is accumulating interest at rates usually below 2%. Your debt is growing much faster than your savings.
If someone has a $2,000 emergency fund and $2,000 of credit card debt, they have two options.
- Pay off the credit card debt with the emergency fund
- Keep the emergency fund and the credit card debt
Paying your credit card debt now puts you in a situation where you have no debt, but if an emergency comes up, you will ultimately have to leverage your credit card for your expenses.
Keeping your debt and your savings puts you in a situation where your credit card debt is accumulating, but if an emergency comes up, you can probably handle it.
If an emergency happened tomorrow, then these two options would leave you in basically the same situation.
But if the emergency happens in a year, then your credit card debt will have grown too much. You’re almost always going to be better off paying off the credit balance now to prevent your debt from compounding over time.
#2. High Yield Investing
This scenario is more controversial.
It could make sense to opt out of a traditional emergency fund is when you partake in investing opportunities with incredibly high yields.
It boils down to this.
If a credit card will charge 25% interest on unpaid balances and your investment will pay 30% or more, then it’s better to put your cash towards the high yielding investment.
You’ll be benefiting from high yields now, and if you have an emergency then you can charge expenses to a credit card and your investments will still outperform the interest accruing on your card.
Importance of Cash Flow
In order to justify keeping a modest stash of cash in case of an emergency, I think it’s important to have a healthy cash flow.
That’s because if you run into an emergency and need to put expenses on a credit card, you’ll still need to be able to pay those balances off over the next few months.
If you have $10,000 of monthly expenses, but only a $500 cash flow, then putting emergency charges on a credit card can easily put you in crippling credit card debt.
But if you have $10,000 of month expenses with a $5,000 cash flow, then it’s not nearly as risky to charge emergency expenses to your card.
What To Know
If you do decide to make credit cards a part of your emergency plan, here are some things to be aware of.
Using 0% interest cards
Some cards offer 0% interest for the first year of owning the card.
In a time of need you may be able to open a card with this perk and essentially negate the high interest problem for a period of time.
You shouldn’t count on being able to do this, however. Keep credit cards available at all times, and only attempt to open one with a 0% interest rate when the emergency hits.
Cash Back For New Cards
Opening a card in a time of emergency can have other benefits.
New cards may also pay a nice cash back sum ($200-300) if you hit a certain spending target in the first 3 months.
Again, you shouldn’t rely on being able to open a new card. Make sure you have a card already available for use, but opening a new card can make a difference if it works out.
Can I Pay My Mortgage With a Credit Card?
Yes! Sort of. You can’t pay a mortgage directly with a credit card, but you can indirectly pay with a service like Plastiq.
In fact this service can be used to pay just about any expense.
Avoid Cash Advances
Taking a cash advance from your credit card has an extra fee on top of the obscene interest rate the card already has.
There is always an alternative to getting a cash advance, so just don’t do it.
Caveats of Using a Credit Card as an Emergency Fund
There absolutely are risks associated with relying on credit to save you in a financial crisis.
Credit availability – One of the risks is that your card providers can lower your credit limits or completely revoke your line of credit at any time and with no warning.
The risk is that when you need credit most, it won’t be there for you to use.
Cost of credit balances – I don’t think it’s any secret that a card balance growing at 20% interest or more is going to become a financial problem if left unattended.
My advice is to think through an imaginary emergency and think about how you would survive using credit. If you can’t imagine how you get through the emergency, then a traditional emergency fund with cash reserves is the right strategy for you.
Certain expenses are difficult to pay with credit – If you invest in real estate, then one of your biggest expenses is mortgages.
You can’t exactly call up you lender and pay the mortgage with a credit card, but there are a few loopholes using services like Plastiq.
Only those in certain situations should consider using a credit card as an emergency fund.
If you happen to be one of those unique few, then you should still think through your doomsday situation and have a game plan. Be ready with a few techniques to help mitigate the risks of holding credit card debt.