Should You Use a Credit Card As Your Emergency Fund?

Over the years, tons of readers have written into me with some variation on the same question: is it appropriate to use my credit card as an emergency fund? Here’s a sample of that question, from Eddie:

I guess what I’m asking is, if I have such a large credit limit that’s not being used, why don’t I just use that as an emergency fund? If the odds that I’m going to ever use it are fairly rare, why should I just keep cash in a savings account when I could be investing it and earning more with it elsewhere?

This is a pretty common situation, actually. People often view their credit cards as their emergency fund – if something happens, they can just throw it on the plastic and take care of the bills later. Most of the time, this scheme works like a charm: it’s easy to utilize this method to handle a lot of simple emergencies like cars breaking down and so on.

Here’s the problem, though: the purpose of an emergency fund is to reduce your personal risk. However, using a credit card for that purpose actually adds significant risk to the emergency fund situation. Here are some of the risks that you face when using a credit card as your emergency fund:

The “size” of your “emergency fund” is at the mercy of the credit card companies. Credit card companies can change your credit limit on a whim. Miss a few bills? Credit card company tightening their belts? The end result of such events can often be a credit limit tightening – and that means you’ve just lost a big chunk of your “emergency fund” right at the moment you need it.

The interest rates can be painful. You lose your job, so you start using that credit card to buy groceries and gas. Eventually, you rack up $5,000 in debt or so on the credit card. Then, you get your job back – but that debt’s not easy to repay, especially at a 19.9% interest rate. Your minimum payments each month are in the hundreds and that just covers the interest and a tiny chunk of the principal. By the time you repay all of it, you will have paid thousands in finance charges. In short, for real emergencies that require a lot of money, the credit cards will bite you hard.

You’re exposed to Murphy’s Law unnecessarily. Using your credit card as an emergency fund opens you up to lots of other avenues of minor risk as well, each of which can bite you when a real emergency comes along. Identity theft is one potential risk. Card use is another risk – the moment at which you need it for an emergency might be a moment when you’ve used it for something else.

A cash emergency fund stowed in a savings account has substantially less risk than the credit card option. It’s safe, secure, and won’t suddenly disappear on you.

There are two big arguments I’ve heard against using a cash emergency fund:

It’s hard to save up that much money. If you want to have six months of take-home in your emergency fund, you’re going to have to save seriously and diligently for a long time. With the credit card “solution,” you can have the card in hand very quickly. This convenience causes many people to justify using the credit card.

If you find yourself in this situation, using a credit card because it’s hard to save up that much cash, your best solution is to establish an automatic savings plan to build up that cash emergency fund on your own. Obviously, if you’re in a situation where your emergency can really only be handled by a credit card, you’ll have to use it, but you should not choose to remain in that situation over the long haul. Take action to make your situation safer – start an automatic savings plan to sweep some cash from your checking account to your savings account automatically on a regular basis.

A savings account doesn’t earn very well. Others look at the cash held there as an investment and thus argue that it should be put into something that has a greater potential for earnings. The argument against this is that an emergency fund is intended to be both stable and liquid – you can always access it and it doesn’t unexpectedly lose value. If you were to invest this cash in other resources, like stocks, you would lose stability and also perhaps lose some of the liquidity (depending on how you invest it).

My suggestion here is to consider your emergency fund to be the cash portion of your overall portfolio – it’s the steady and stable part of things. This allows you the freedom to seek out other investments that are perhaps more aggressive than you might otherwise consider, like stock investing in developing countries.

Here’s the take-home: a cash emergency fund, stowed away in a savings account, is as safe and secure as you can possibly get, which is exactly what you want from an emergency fund. If you’re in a situation where you rely on a credit card for your emergency fund, you need to start transitioning away from that – try an automatic savings plan to gradually move cash from your checking account to your savings account.