Using Credit as an Emergency Fund is a Bad Idea

credit emergency fund

Not too long ago my neighbor needed a new water heater. After it was installed, we went on one of our daily walks and she moaned about the expense and hassle.

“Well,” I said, “at least you covered it out of your emergency fund, right?” I’ve heard her speak about their emergency fund so I simply assumed that the replacement water heater had been paid for using emergency cash.

“Oh, sure. We put it on the HELOC.”

“Huh? I thought you had an emergency fund,” I said.

“We do. That’s what the HELOC is for.”

Oh, man, I thought, seeing the huge risks and holes in this plan. Turns out the emergency fund I’d heard her speak of before wasn’t made from cash, as I’d assumed (yet again, this proves the wisdom of the old adage about assuming). Her emergency fund is made up of credit.

She’s not the only one. I’ve heard of many people who use credit cards, HELOCS, and other loans as emergency funds rather than saving up cash. Their thinking goes that those lines of credit are just as good as cash and easier to access in an emergency when compared to transferring money out of a savings account or cashing in a CD or stocks. Many of them are certain that they will be able to pay if off before paying much, if any, interest. Some simply can’t be bothered to save up the cash, while others use this method because they want to do other things with their cash like invest, buy real estate, or simply spend on things that are more fun.

Using credit as an emergency fund carries a few big risks, however. First, if you’re using a HELOC you’re essentially putting your house on the line. A home equity line of credit is guaranteed by your home so if you can’t pay back the loan, the bank can take your house. If my neighbor can’t pay for that water heater, she could lose her house.

Second, credit lines require that you pay interest. While a HELOC might be low interest, you’re still paying interest. And credit cards can have interest rates as high as thirty percent or more. If you’re using payday loans for an emergency fund, you could easily be looking at a one-hundred percent interest rate. If you don’t pay these lines of credit off immediately, you’ll end up paying far more in interest than the original emergency would have cost.

Many people have found themselves hopelessly in debt using the credit as emergency fund strategy. They start with the best of intentions. They swear to pay it off right away and not to use it for anything other than an emergency. But things go wrong. An emergency happens around the holidays and that credit card gets tapped for holiday spending in addition to the emergency. Or more than one thing goes wrong at once, meaning that you have to put more on the credit line than you intended. It doesn’t get completely paid off in the first cycle and so the interest starts accruing. Now the payments are higher than you planned. And on it goes until you are deeply in debt, all from one emergency that could have been handled, in cash, with a regular emergency fund.

Using credit for an emergency fund only works for those who are disciplined enough to pay it off immediately, every single time. This usually means once of two things: Either you have a very high income that affords you enough cash to be able to pay it off before the interest begins, or you have other assets such as stocks that you can liquidate to pay off the debt. For most people, though, using credit as an emergency fund is a strategy to avoid. It may be painful and require sacrifice in the short term, but you’re better off stashing some emergency cash in a savings account.

(Photo courtesy of eliazar)

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7 Responses to Using Credit as an Emergency Fund is a Bad Idea

  1. MG says:

    When I first got out of college I got an awesome deal on a card with a low interest rate. Unfortunately, I can’t catch a break. I had a fully laid out plan to get out of debt. Then I lost my job. Then my car’s brakes needed replacing or I couldn’t go to job interviews. Then my car’s serpentine belt snapped and killed the water pump. Between those two things on my car, I had to charge $700 to my card. Then my teeth started throbbing from the pain and I couldn’t do anything about it. I tried taking the strongest over-the-counter painkiller I could, but that didn’t work after a time. I paid for a filling off of insurance at the time. $250 for a resin filling and $85 for the appointment and xrays. All on a card.

    Keep in mind I’m still out of a job. I charge meals, gas and everything to my card. Now I have a job and a great, steady income. The problem? I now have $8,000 in CC debt and $26,000 in student loans. When I’m at my full-time job, I now write freelance articles for various high profile bloggers. I’m trying to pay off my debt and be a good credit card owner.

    The problem I have is that most people are in much better positions and can say “Why didn’t you pay it in full?” The answer is “because I would have starved and could never have gotten a job or paid rent without my card.” My credit holders are awesome and they’re great about payments. I’m on my way out of debt now but it won’t be until 2019 that I’m completely debt free (student loans and CC debt).

  2. I used to do this, but have since learned the error of my ways. If there is an emergency, I will still put the amount on my credit card, but I will pay it off immediately. I only do this to ensure cash back rewards.

  3. I dumped the balance of my credit cards on to my HELOC more than once. I have learned my lesson but now it will be years before I am debt free. A very expensive lesson that will delay my retirement by 1 or 2 years.

  4. Petunia 100 says:

    Another problem with relying on credit for your emergency fund is that the creditor can reduce or close your credit line at any time for any reason. But cash in the bank is yours, it cannot be taken away on a whim.

  5. I know a few people who say that their line of credit is there emergency savings. ie: If we go over budget this month we will just put it on our line of credit. In my opinion if you don’t have the cash it’s not there, there is no money. So if there is an emergency you are spending money you don’t have. Some people think that having money in an emergency account is rubbish and investing it is the way to go. It’s all personal opinion really. I certainly would opt away from depending on a line of credit as an Emergency Savings though.

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  7. Gailete says:

    MG I hear you on this one as sometimes there just isn’t ANY cash left, but life keeps happening. I have found that as we have dug ourselves out of debt and put cash aside for bills that it gets easier and easier. That still doesn’t mean that a huge problem won’t come up that sucks up every bit of spare cash that you have and then some. When it comes to credit cards I see things a bit differently. You shouldn’t be using them for clothing, and unnessary stuff (and clothing is unnessary–how many people do you know that don’t have more than one change of clothes?). But when life’s disasters happen and you have no money, a credit card is sometimes the only way of keeping food coming in, although you should also be looking for ways to get cash coming in (any legal way) to avoid the use of credit. But the more you learn to live a frugal lifestyle, the better.

    I do think that some folks have never run into a true emergency in their lives. I once worked at a college and lived in staff housing along with 2 other ladies my age in our own apartments. We all had the same basic job, so they should have been making the same basic money that I was. I would make Kraft Mac and Cheese last for 3 meals or a tuna casserole for 4 meals. I didn’t buy anything new, etc. I didn’t have a car (didn’t even have a lisence to drive), yet these girls both had nice cars (not beaters), nice clothes and never seemed to be pinching pennies. All I could guess was they were still being subsidized by their parents and had left home with an adequate wardrobe for working that I didn’t have. I had spent the year before this job working at Arbys in uniform. I don’t know where those girls are today, but having a boost of coming from a wealthier family who can pitch in when needed in those early ‘on your own’ years can make such a huge difference in how people can handle emergencies and their funds as they continue on in life. Lots of kids are graduating now with piles of debt and don’t have any way to adequately support themselves while paying off that debt and so they fall further and further behind. Only frugal living and belt tightening can help them get out of the debt, plus finding every opportunity possible to earn money.

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