How to Use Plastic as an Emergency Funding Tool

As a last resort credit cards can work as a substitute for savings, but only if you use them carefully and vigilantly.
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Right before the global financial crisis of 2008, economists were shocked by the lack of savings set aside by American families. The average savings at that time dipped into negative territory for the first time since the Great Depression. That meant that the typical consumer was spending more money than they actually earned. Not only were they not setting aside anything for a rainy day, but they were going into debt month after month -- a real recipe for financial disaster.

The warning signs were loud and clear, and soon the nation fell into one of the worst recessions in history. Most people who endured that difficult time learned some hard lessons. Consumers started doing a more conscientious job of budgeting, for instance, and cutting back on unnecessary expenses.

Americans Lack Savings

Things have substantially improved, but unfortunately the savings rate in the U.S. is once again extremely low. As reported by media outlets including NBC News, more than 60% of American consumers lack the savings to even handle a $500 automobile repair.

The Federal Reserve conducted research last year that also found that many households across the country have siphoned off whatever money that had saved as a safety net. In fact, 57% of those surveyed by the Fed reported that they had tapped their saving - or used it all up - while struggling through the long recession that began in 2008.

Only about half of respondents have enough saved-up to weather a $400 medical emergency without resorting to borrowing money or selling off items. In the absence of a rainy day fund, most people who are faced with unexpected financial challenges try to borrow from family and friends, or they max-out their plastic. See the full report.

Credit Cards as a Simple Safety Net

As a last resort credit cards can work as a substitute for savings, but only if you use them carefully and vigilantly. Otherwise borrowing against your credit on plastic can backfire and exacerbate your financial woes. Here are some helpful tips if you find yourself in a position to use your credit cards for an emergency:

  • Choose a credit card with the lowest possible interest rate, and try to earmark it for emergency use only. Set that card aside instead of carrying it in your wallet and don't use it for routine purchases.
  • Only use the card often enough to keep the account active, which could mean charging a small amount every few months.
  • Always pay off that balance immediately, to avoid any late fees or penalties.

If you face an unforeseen financial crisis such as an emergency room visit, this emergency credit card will be available to you as a back-up source of urgent funds. Since there is no balance on the card and it has a reasonable interest rate, it can serve as a loan to yourself that you can then work on repaying as fast as possible.

How to Maximize the Value

To get the most out of this kind of arrangement, it is important to select a credit card with an adequate credit ceiling. You may also want to try to use one that offers an attractively cheap introductory rate on balance transfers and cash advances.

There are cards that offer introductory rates as low as zero percent for 12 months or more. These are ideal for this kind of emergency use, but also check to see what other fees are involved. Credit cards typically charge a one-time fee for doing a balance transfer, for example, which may be a minimum charge or a percentage of the amount you are transferring. The same goes for cash advances, although doing a cash advance is usually significantly more expensive.

Study the rates and charges, which can be found in the section of the credit card disclosures called the Terms and Conditions. You can also use our website to read reviews and find suggestions for the best credit cards offering 0 percent APR or those that have low fees like credit cards with no annual fee.

Saving vs. Paying Off Credit Cards

Another thing to consider in regards to savings is whether you should use your available cash to pay off your credit cards, or take that money and put it into a savings account. After all, it is smart to do both of these.

  • For example, if you owe 250 on your credit card, but you receive a tax refund of 300. You are going to have to pay interest on that 250 for as long as you carry the balance. For the sake of example, let's say that the rate is 16 percent. That means that over a year's time you'll pay about 16 percent of 250, or around 40, just for the convenience of carrying a balance. At the end of a year you'll then owe 290 or more on that same balance, and interest paid on credit cards is not tax deductible like mortgage interest is.

At today's interest rates, you might earn only a few pennies by putting that tax refund into a savings account. A smarter strategy would be to use the tax refund to pay off that plastic because you'll automatically save yourself in interest costs.

Savings is Golden

Once you've paid off your plastic, by all means set aside any other extra cash you save in order to establish a rainy day fund. Even if you only save a little each month, it will add up over time. You'll also be in a rare category of Americans who actually have some emergency funds, and that's a status that should make you feel more stress-free and proud of your financial management expertise!

This article originally appeared on Using Plastic as an Emergency Funding Tool.

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