Is it OK to use a credit card as an emergency fund?
Wise financial advice dictates only putting on your credit card what you have the cash to pay off in full each month. Credit cards are not meant to be loans, but rather payment tools used in certain situations.
However, many people rely on a credit card for financial emergencies. In fact, credit card companies often cite the advantages of having a card for use just in case it's needed. There's little wonder why.
Statistics from the Canadian Payroll Association show that almost half of Canadians would have trouble meeting their financial obligations if their paycheque was delayed by even one week, and 24 per cent say they could not cover a $2,000 emergency if one arose within the next month.
So when is it OK to use a credit card for a financial crisis, even though you might not have the cash to pay off the balance when the statement comes?
According to Joanna Marks, a credit counsellor with Financial Fitness based in Windsor, the answer depends on how you define an emergency.
"I feel there is a big difference between mismanagement of money, and misfortune," she says. "Many ‘emergencies' are predictable; for instance, car repairs, home maintenance and Christmas, so it's very important to plan for expenses that you know will be coming up."
Budgeting for those things that you know will occur throughout the year will help you avoid using credit to supplement your income, a practice that results in mountains of debt.
Even in true emergencies,
resort to credit last
Some life events are less predictable, and for those Marks suggests you think of all the options available before you reach for your credit card. In the case of a layoff or an illness that prevents you from working, she advises checking to see if there are community resources that can help you get through the tough time without racking up a big credit card bill.
Bruce McLennan, owner of McLennan & Co., Licensed Insolvency Trustee, says he tells his clients to make sure they have some savings built up to handle emergencies.
"We advise them to build up a nest egg, have a savings account," he says.
While common financial advice dictates having several months' income set aside, McLennan says that's not always realistic.
"That would be thousands of dollars," McLennan says. "People just don't have that." Instead, he suggests stowing away at least enough for a minor emergency, such as a car repair. Even $500 to $1,000 is better than nothing.
If there are no other options available, then a credit card can help when hard times hit.
"I would never tell anyone not to use credit for a dire emergency," Marks says, so long as you're sure the credit is being used for a misfortune that can't be resolved in any other way. "Look at the big picture to see if it's a sensible option."
If you use credit, have a plan
"You should never put yourself in a situation where you don't have a plan to pay it back," says McLennan.
That doesn't mean the ability to make just the minimum payment, either. "They feel that they're balanced because that's all the credit card provider has requested," McLennan says. He says he's seen credit card statements showing it would take more than 100 years to pay back the balance if the borrower makes only the minimum payment.
Paying the minimum temporarily (while you're still in the throes of the crisis) might be OK, but as soon as you're back on your feet, plan to put as much as you can toward the debt, especially if it's racking up interest.
When planning to pay back your credit card balance, Marks says you need to go back to the beginning - what got you into this financial situation.
"I would suggest that they sit down and do a full forensic on their budget," she says. A good budget strives for balance - not just making sure the numbers add up from month to month, she says, but that there's wiggle room for tough situations, and allotments for the periodic expenses that you can predict.
Both Marks and McLennan pointed to a psychological battle that can come with credit card use. Marks says we can errantly talk ourselves into a credit card purchase by thinking there will be more money coming in the following month.
"We have that good guy on one shoulder and the bad guy on the other shoulder, and the conversation is not always in our best interest," she said.
Credit may come to your rescue in an emergency, but be sure the financial crisis is real, and that you aren't just listening to the bad guy on your shoulder telling you to use your card. And when it is a true fiscal emergency, don't get lured into a false sense of security - pay down the debt before it becomes a lasting problem.See related: What to tell your creditor when you can't make payments, In an emergency, what comes first: savings or credit?, When paying less than your full card balance makes sense
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