Credit Card Emergency Funds – An Alarming Trend in Society

The following is a guest post by Jacob from My Personal Finance Journey, a personal finance blog offering actionable personal finance advice with the goal of achieving long-term success. In particular, Jacob focuses on long term investing and asset allocation strategy analysis, deciding how to prioritize new funds as they come in to various spending requirement areas, and how to develop a lifestyle of frugality.

Several months ago through the magic of LinkedIn, Brad and I were able to find out that we actually lived in the same city in Virginia. This was quite an awesome find, being as that the personal finance blogging community is relatively small, and most of the other bloggers I’ve met are scattered throughout the better part of the United States and Canada.

Since finding out we lived in the same city, I’ve been eager to find ways to team up with Brad and Enemy of Debt, and I figured a guest post might be a good way to do this!

However, being as that the name of the site is Enemy of Debt, I wanted to wait until I had an appropriate topic that might be well suited for his audience.

Recently, while talking to a group about regularly saving for an emergency fund, one of the class participants mentioned that his primary source of funds in the event that an emergency arose was his credit card. 

I have to admit that I was slightly surprised to hear that this was his plan for handling emergency expenses. However, when I started to think about how money for many families these days is very tight due to the economy, I figured that it’s highly plausible that many other people out there either are using or thinking of using their credit card for their emergency fund as well. Since (as you can imagine) using your credit card as your emergency fund can have a potentially huge impact on your current debt levels, I figured it might be a good topic for discussion on this site.

What Exactly Is An Emergency Fund?

Since Brad has discussed emergency funds several times previously on Enemy of Debt (I particularly liked reading the O Emergency Fund, Where Art Thou? post), I’m sure most of you are well aware of what this instrument is and the purpose it serves.

However, just to make sure we are all on the same page, listed below is the way I interpret the advice about what an emergency fund is and what it is to be used for:

  • An emergency fund is a cash reserve account stored in a high yield money market account that contains approximately 6-9 months (amount can vary based on personal needs) worth of expenses.
  • The purpose is to provide income in the event that you become unemployed or cover unexpected serious expenses that are necessary for your normal income creation to continue.

Using a Credit Card as an Emergency Fund

In a previous post, Brad mentioned that an emergency fund is perhaps the number one best way to avoid debt. I would have to say that I agree with him 100% on this. This is because when unexpected expenses inevitably arise, you have a source of funding to pay for them instead of having to take out a new loan.

So, even though it is obvious that using a credit card as your sole source of an emergency fund would be a very GOOD way to NOT avoid debt, I was curious to find out just how prevalent this trend is in our society today.

According to articles from Perkstreet and MSN Money, it appears that about 45% of Americans do not have an emergency fund and would resort to credit card debt in the event that a financial catastrophe befell them. 

Problems With Using Your Credit Card as Your Primary Emergency Fund

From the statistic above that over 40% of Americans would resort to using their credit card as their primary emergency fund, it is quite clear that the man from the class I was talking to was not alone in this potentially dangerous habit.

As such, I wanted to take a few minutes to explore some of the obvious and maybe not-so-obvious problems that could arise from the practice of using a credit card as an emergency fund. These are listed below:

  • Racking up more debt from the high interest rates carried by credit cards – 
  • This one is pretty straight-forward. Since the average interest rate on personal credit cards is between 12-15% and accrues daily, the balance you owe can increase very quickly!
  • Credit card could be closed and/or your balance lowered – 
  • At the end of the day, the money you spend using a credit card is, in fact, a loan. It is not your money. So, you can run the risk of your card’s balance being lowered below what is needed to sustain your family in the time of an emergency or having your card closed all together.
  • Negative momentum (both real and psychological) of getting out of debt – 
  • I know that Brad talks about the psychology of debt/money a lot on this site, so I wanted to point out that if you are making progress paying off debt and run in to an emergency that causes you to use your credit card, any forward momentum you were making will be difficult-to-impossible to maintain.
  • Can you buy everything you need with a credit card? 
  • Another set of potential problems that comes to my mind when thinking about using a credit card as your primary emergency fund is that you either:
  • 1) Do not have enough remaining credit to support yourself and your family in the event that you are unemployed for a long-term period, or
  • 2) Cannot use a credit card to pay for all of your required expenses (see next section below for more detail).
  • Regarding potential problem #1 above, in doing some research on eHow, I found that the average consumer has a total credit limit of ~ $19,000 spread over 9 credit cards. While this total credit limit is likely sufficient to support you for emergency reasons, it is also highly probable that consumers will already have credit card debt and not have all of this credit limit at their disposal at all times.

Things That Cannot Be Purchased Using a Credit Card

In today’s society, let’s not kid ourselves – it seems that EVERYTHING can be purchased using a credit card. In fact, I personally only carry cash in my wallet for emergencies (pardon the reference to the topic of this post) and use personal checks sparingly. However, I always make sure to pay off my balance in full each month.

As such, I thought it might be interesting to do some thinking about things that CANNOT be paid for with a credit card that would present a problem to people planning to use a credit card as their primary emergency fund.

Listed below are some of the items I found that cannot be paid for using “plastic,” as well as some items that I was surprised to learn can be paid for with credit card:

  • Rent – 
  • Depends, but I personally wouldn’t count on it. Some company-type landlords I have had offered the option of paying rent via credit card with a transaction fee. For one-person operation landlords, I would imagine that credit cards would not be accepted.
  • Mortgage – 
  • Cannot. I did some reading on this, and apparently, several banks used to offer mortgage payment options by credit card. However, it appears that these programs were cut after the sub-prime fiasco in 2008-2009.
  • Federal/State Income Tax –
  • Can use a credit card, but involves a transaction fee. I really can’t believe they let people do this!
  • Student loans –
  • Amazingly, you can use a credit card! Wow!
  • Car loan –
  • Depends. Some financing companies let you, others don’t. 
  • Credit card debt minimums – 
  • No. While there may be some loophole to do this, but it just doesn’t make any sense. Let’s stay away.
  • Electricity bill – 
  • Can use a credit card, but involves a transaction fee.
  • Homeowner’s Association Fee –
  • Can use a credit card, but involves a transaction fee.
  • Insurance – 
  • Can use a credit card, but involves a transaction fee.
  • Property tax – 
  • Can use a credit card, but involves a transaction fee.
  • Car repairs over a certain limit –
  • Where I get my car fixed, credit cards can only be charged a maximum of $3000 for repair work.

To my amazement, many of the expense items listed above (even loans/other forms of debt) actually can be paid for with a credit card. Who knows – perhaps we’ve uncovered why America has such a high credit card debt – because consumers use one type of debt to pay off another, becoming a terrible cycle? However, in almost all cases, a convenience/transaction fee is charged, further increasing the cost to you beyond the high interest rate you incur on the money loaned.

Conclusions

So, what’s the bottom line with all of this?

Although I suppose having a credit card tucked away as your emergency fund is better than having nothing at all, in my opinion, relying solely on a credit card is a very bad idea for anyone trying to be debt free and financially independent. This is because unexpected urgent expenses and/or job-loss are inevitably going to pop up, and without a self-sufficient emergency fund, you could rapidly rack up thousands of Dollars in credit card debt that could take you anywhere from 2-10 years to recover from. Additionally, do you really want to take a chance and depend on someone else’s money to provide for you and your family in times of emergencies?

How about you? Do you have an emergency fund? If so, in what type of account do you house the money? 

Do you know anyone that uses their credit card as their primary source of money in the event of an emergency? Do they do this because of a lack of money overall or because they prioritize their money elsewhere?  

Share your experiences by commenting below!

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19 Responses to “Credit Card Emergency Funds – An Alarming Trend in Society”

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  1. Thanks for the chance to guest post Brad! I look forward to reading people’s input!

  2. This seems like such a crazy idea! I feel like it would be real no-brainer that using a credit card as an emergency fund would only result in deeper debt. Thanks for writing this post, as apparently some people still need to hear it. Personally, I don’t have an emergency fund yet, but I’m at a place in my life where it is not very necessary and/or practical. I know several people who do, though, and mostly in high-yield accounts, like ING. As soon as I get a regular income, though, establishing an emergency fund is at the top of my financial goals list.

    • Thanks for reading Deborah. An interesting question semi-related to this is whether or not recent college graduates need an emergency fund?

      For many of them, their parents are still able to assist them in the event that anything happens. So, they may not NEED an emergency fund in the traditional sense. However, it might also be beneficial to begin saving up a cash reserve for this purpose for several years down the road when they are more “on their own.”

  3. Question: If you are using the credit card transfer convenience checks, would a typical mortgage company or bank accept that?

    I think one reason, though maybe not a large factor, that people turn to credit cards in an emergency is a punitive effect. I have known people that when facing tough times, charge up a bunch of stuff they know they won’t pay for. Almost a way of lashing out at the “system” that is keeping them down.

    • Good question John! In researching for this article, I just saw that credit cards could not be charged for paying mortgages these days. However, my guess is that convenience checks would be likely to be accepted, since it’s technically a check carrying your name (similar to if you sent the mortgage company a check from your current bank) and not a credit card transaction. However, these convenience checks come with a whole melieu of fees and interest rates, so probably not a good idea! haha

  4. Clair Schwan says:

    I had a conversation many years ago with an individual who had just be laid off. Knowing that they were living on the financial edge, I asked about their plans to fund their basic necessities like rent, groceries, and utilities. Their response floored me. After exhausting their minimal savings, they noted, “There’s always the credit card.” You don’t need a crystal ball to see debt in their future. What are some people thinking?

    The single largest problem with credit cards is that people see them as a means to give themselves a personal loan. As you point out, they aren’t. They’re a means to conduct a transaction, just like cash or a check. When we look at credit cards as a means to provide ourselves a loan, or an emergency fund, that’s when we get Congressional fever and start playing fast and loose with “someone else’s money.”

    Credit is like many other things in life, some people just can’t handle it. Harry Callahan was right, “A man has to know his limitations.”

  5. Michelle says:

    Wow, I don’t know anyone who uses their credit card as their EF (well at least to my knowledge). Not smart.

    • Brad Chaffee says:

      Haha I think you’d be surprised at how many do. Of course getting people to admit they do is not easy but I have known a few people openly admit it with no shame at all. Most of them didn’t think there was anything wrong with it nor did they feel it was risky. That’s denial hard at work. LOL

  6. Lynda says:

    After taking Dave Ramey’s FPU Course a year ago and determining to get really serious about being debt free, we went right to his plan and created our baby emergency fund, then as part of my budget we have been adding to it as regular alloted funds. Glad we have. I’m on track to get out of debt in a few months, but could have had a real set back this month when an unexpected water leak has caused us to have to rip up kitchen flooring and replace it. Because of my emergency fund we can manage this surprise without it throwing our budget off track, or adding debt. Having cash allowed us to take advantage of a fantastic deal on what will be replacement materials. It is a challenge breaking the debt habit, but the closer we get the more there is such a sense of liberation, and my emergency funds and new habits are to prevent us ever getting back into the debt trap. We are using this time to train up our kids in debt free thinking habits too : )

    • Thanks for sharing Lynda! I’m glad to hear that Dave’s techniques/advice worked for you. I recently read his book, and was very intrigued by the funds prioritization order he recommends.

      Question: did you find that having the baby ($1000) emergency fund was sufficient to move to paying off debt? Or, do you think people should accumulate a larger emergency fund first before starting to pay off debt more significantly?

      • Brad Chaffee says:

        By funds prioritization I’m sure you’re referring to placing your debts on the debt snowball from smallest to largest as opposed to the mathematical approach, from largest interest rate to smallest.

        We used the smallest to largest balance method and I can tell you it was great for keeping us motivated *ESPECIALLY* in the beginning of our journey which was when we needed it most. at that time most people are dealing with changing a combination of financial behaviors and financial mindsets. It’s a big adjustment.

        When you’re dealing with so much change paying off a debt every time you turn around is HUGE! Now if you have two debts both equaling the same amount then obviously you would choose to pay off the highest interest rate first.

        Imagine if your highest interest rate debt was also your largest debt. You’d be treading water for a long time without any payoffs and that is why Dave Ramsey suggests that prioritization strategy. When someone is in debt and has obvious financial behaviors that need to be changed it’s no longer about the math. Math won’t get you out of debt.

        I recently had a reader (financial advisor) email me after reading my debt snowball post suggesting to use the same lowest to highest strategy. She told me that even when you do math the difference between the two in terms of how much less you pay is very little (or at least not as much as people think).

        Think about it. If you’re paying down debt and it takes you longer simply because you’re not quite as motivated to be as hardcore about it as you are in the beginning, then chances are you’re going to give up (which most people end up doing). However, when you eliminate a debt or two each month it motivates you more and more to dig deeper and try harder to pay off more the following month.

        As for the emergency fund. We personally saved $2,000 instead of the $1,000 Dave Ramsey suggests. We did so because my wife wanted more. As it turned out we never had an emergency that took more than $1,000. Actually most of them were closer to around $500.

        I wrote a series of baby step posts that gives the readers a choice to kind of do it their way depending on their own circumstances and attitudes about debt elimination and personal finance but still followed Dave’s plan.

        The point of the Total Money Makeover is to get rid of that debt as FAST as humanly possible by bringing a level of intensity to the process and focusing on one financial element at a time. That is why I believe so many people have become debt free using Dave’s approach. It works!

        If course, his way isn’t for everybody but it is very very effective if you stick to it. 😀

        • Well said Brad! It’s so interesting to me the way that there is so much psychology involved in financial planning, especially in these debt payoff/funds prioritization decisions.

          I think it’s a good idea to leave it up to the individuals to decide exactly how much of an emergency they need. I think for me personally, I am sort of a “worrier,” so I would probably lean towards the higher emergency fund level before moving to aggressively pay off debt. I would essentially want to have enough to cover several months of living expenses if my company were to downsize or something would happen with my job outside of my control.

          Another interesting question I had in reading Dave’s Baby Step / prioritization order was this:

          Does Dave’s Baby Step / funds prioritization order have a maximum timeline associated with how long it will take people to pay off their debt? For example, what if someone has so much student loan and consumer debt that it will take him or her 10+ years to pay it off? Does Dave’s Baby Step order still apply, or does it assume that someone will pay off the debt in less than 2-5 years? I am just wondering if it will take someone 10+ years to pay off their student loans + credit card debt, should they still completely refrain from investing for retirement during this time?

          • Brad Chaffee says:

            I agree with not boxing in one method as the “only way” to get out of debt. While I certainly agree and highly recommend Dave Ramsey’s Total Money Makeover I realize that it may not be for everyone. Just like other methods people recommend didn’t work for us and that’s the beauty of personal finance. There’s always a way that works for “you”.

            As for your question Dave is pretty adamant about sticking to his baby steps and for the most part I would agree. For extreme situations Dave recommends second jobs and increasing income to speed up the process. I personally wouldn’t fault anyone for investing a percentage of their income while they’re paying off debt but the point is to get rid of the debt so you can then use that money for building wealth and retirement so the more you take away from “payoff” money the longer your income will be tied up. That’s Dave’s philosophy.

            Do EVERYTHING YOU CAN to pay it off and free up your income so you can then aggressively save and invest.

            Most people can get out of debt in less than 10 years if they use Dave’s approach. I personally know people who deliver pizzas on the weekend to make an extra $1,000 a month. The key is to never stop looking for opportunities and to never settle for average. Working hard for a short period of time can go a long way when you want to enjoy the freedom that comes with eliminating debt.

          • Brad Chaffee says:

            Per Dave Ramsey, the average time it takes people to complete the Total Money Makeover (thru baby step 6) is approximately 5-7 years. This all depends on lifestyle and how bad someone wants it obviously.

          • Thanks for all the info Brad! This has given me a lot of good experiences to think about.

            But yeah, I totally agree. If someone can truly commit to paying off debt in 5-7 years, it’s worth putting investing on hold to get the debt balances down.

          • Brad Chaffee says:

            If you enjoyed The Total Money Makeover you may like his newest book called EntreLeadership. It is AWESOME!! I’m reading it now and have loved some chapters so much I have read them twice! His leadership principles are rock solid and I really admire how he has built his company and the approach he uses with his “team”. (He doesn’t call them employees.) His intro story about starting his counseling business from a card table in his living room and how he built his team from the ground up with these principles is very inspiring. 😀

            In fact, I think you may like it more than The Total Money Makeover!!

            Praise from the book:

            “Like Dave, I believe that a business isn’t good unless it also does good — for its employees, partners, and the community it serves. A business cannot have true success without also having a soul. In this book, Dave shows us how to have both; great leaders who are also great people; great companies who are also great families. Entrepreneurs are needed in America now more than ever — but there’s a big difference in starting a company and leading one. And there is an even bigger difference in a company that’s valuable and one that has values. But Dave has figured out the recipe to having both things at once, and his lessons are invaluable.”

            Thought you might be interested. 😀

  7. Clair Schwan says:

    Lynda, your experience demonstrates what I always tell people about having money – it provides you with options. Instead of taking on debt or changing your budget, having cash on hand gave you the option of continuing on as usual, instead of letting the water leak upset your apple cart.

    With respect to your children, no matter what you tell them, what will likely stick with them is what you do, what they see, and what they sense. Lead by example, and they’ll benefit greatly for the rest of their lives.

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