A Credit Card Isn't an Emergency Fund
By: manybanking.com Staff

By Jeffrey Strain, TheStreet.com

Many people consider a credit card their emergency fund. While convenient, it's rarely a good idea for most people, especially during times of economic turmoil.

There seem to be two reasons that people opt for the credit card as an emergency fund rather than building a stash of cash in a savings account: the time it takes to raise enough money and the paltry interest earned from a bank account. Here are a number of reasons to reconsider.

Better interest rates: Placing emergency-fund money in an investment that earns a better return than a savings account usually relies on the false assumption that some securities always rise. Stocks and other investments can be volatile, especially in the short term.

Since by definition an emergency occurs unexpectedly, money invested in other financial vehicles might need to be withdrawn at any time. This includes times when it isn't financially in your best interest to do so.

Time factor: There is no doubt that it takes time and discipline to build up an emergency fund. In doing so, you may even need to use a credit card as an interim safety net. But, eventually, you will have saved enough money.

Credit card limits can be reduced: Credit card companies, to reduce risks, are lowering spending limits, even on cards whose owners have good credit. The likelihood of a reduction increases as your financial situation worsens. If you lose your job or fail to make payments on some debt obligations, it's possible your credit card limit will be cut.

Credit cards can be canceled unexpectedly: Even worse, companies can take the reduction in the credit card limit a step further and cancel your agreement altogether. You will still owe any amount you have on the card, but you may no longer use it. In this situation, the entire amount you were counting on in case of an emergency disappears overnight.

High credit card interest rates: When a credit card is used as an emergency fund, not only will the principal need to be paid off, but also the double-digit interest that accrues. That means you will have spent much more than just the emergency itself.

While relying on your credit card entirely for your emergency fund can be financially dangerous, it doesn't mean it should be abandoned entirely. Many emergencies need to be taken care of on a moment's notice, and a credit card can be a convenient way to initially pay for the charges. Then the credit card can be paid off with the emergency fund in the bank account before any interest charges are incurred.

—For more ways to save, spend, invest and borrow, visit MainStreet.com.

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