In an emergency, what comes first: savings or credit?

Ask any finance expert and they'll say the most important priority for most Canadians is creating an emergency fund. It should cover three months' living costs at the minimum -- six to eight months' is optimal -- in case you lose your job or have some urgent one-off expenses. For most people, that means socking away at least $10,000.

However, 56 per cent of those questioned in BMO's 2015 Rainy Day Survey say they have less than $10,000 in emergency savings, and 44 per cent have less than $5,000. Almost 30 per cent conceded that they don't even think their savings can carry them through one month.

"In credit counseling, we see people who've had unfortunate circumstances," says Pat White, executive director of Credit Counselling Canada. "It's quite sudden and emergency savings set aside can make a huge difference so you don't have to use credit and go into debt."emergency-funds

Emergency circumstances may include medical expenses, job loss,
a car dying and unexpected home repairs. Those are the issues that worried Canadians most, according to the survey.

But when the emergency isn't clear cut, such as a broken fridge or your annual car inspection that you forgot to budget for, it can be hard to know if you need to dig into your carefully-saved (and maybe
limited) funds, or just grab your credit card. Two credit counselling experts weigh in on how to determine if your situation is a crisis, and which account to hit: savings or credit.

What constitutes an emergency?
"An emergency is an event that's unexpected and catches you out of the blue," White says. "You aren't prepared for it." True emergencies have a high sense of urgency to them.

That means that while job loss or a broken hot water tank are true crises, finding out that you're the only person in your group of friends without tickets to that pricey music festival is not. Additionally, if you simply forget to budget for something, such as your annual HOA fee, Christmas or your annual car inspection, it may be an immediate, unplanned cost, but it isn't considered an emergency.

"Sometimes an emergency isn't an emergency," White says. "It's poor planning."

Some situations tread the line. For instance, if your car breaks down, you may feel the need to dip into savings to put a down payment on a new one. However, if you can take public transportation or carpool, this purchase may not be a pressing need, and could be something you save for separately instead.

Emergency fund or credit?
Whether you should dip into your savings or pull out plastic depends on the cost of the emergency, the experts say. If it's nominal, such as a $300 deductible for a car insurance claim, you can swipe your card, but only if you have a repayment plan in place for the sum.

"If it's something you can manage, you can leave your emergency funds intact," says Brian Pritchard, a credit counsellor and senior vice president at BDO Canada.

It may even be a life lesson: you might realize you need to reorganize your budget to account for annual costs or you need to kick-start an emergency fund.

However, some situations are ongoing, such as a job loss or health issue. In that case, you'll need to reorganize your budget. You may even need to access other savings, such as a Tax-Free Savings Account (TFSA).

Try not to rely on your credit card unless absolutely necessary, and do not underestimate the severity of the situation. Seek help before you get to the point of using other savings or credit, White says. Visit a credit counsellor who may help you with budgeting, informing your creditors of your predicament and setting up a plan for the tumultuous months ahead.

"If people are laid off, they hope they're going to get a job or something will change and they live the lifestyle they did when they worked," says White. "You need to make serious changes before it snowballs."

And if you do turn to credit, make sure you've exhausted all reductions in your spending, Pritchard says.

"Credit is easy to use in an emergency but it's easy to rack up with a sizeable expense because of interest on the debt," he says. "It's just going to continue to escalate until you're through the crisis."

Finally, once you've recovered from the emergency, it's important to aggressively repay the debt and rebuild your savings, even if it means continuing to live off your revised budget until you're back in a stable place.

See related: 7 tips for staying out of debt when unemployed, 5 factors in choosing a debt consolidation plan, Is 'fear of missing out' driving millennials into debt?
Published October 13, 2015

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