Emergencies are the worst time for using debt

ExxonPhoto courtesy of Mike Mozart

Not long after I got my drivers license, my mom gave me an Exxon card to carry around with me. “For emergencies, in case you run out of gas and are stranded.

I never used it. It’s not that I had any special objection to using it at the time (aside from not wanting to spend my parents’ money) but I was never in a situation where I needed it. Gas was expensive for me at the time, but it wasn’t that expensive.

Still, I appreciated the offer. Moreover, I appreciated the trust my mom put in me (though I guess with a gas credit card, it’s not like I could really run up the tab all that much).

More broadly, you see this argument for credit cards quite frequently. “Keep your credit cards around in case of an emergency.” It seems sound on the surface, but does it hold water?

What makes an emergency?

I define a financial emergency with three U’s:

  • Unexpected
  • Urgent
  • Unavoidable

If a financial situation is all three of those (and really, I mean all three) then you have a bona fide emergency.

I recommend everyone build an emergency fund of six months of bills and expenses in the bank, to use in these situations. Why not less? Because it might not be enough. Why not more? Because it’s a very rare emergency that will wipe out that much money, and we have so many other financial goals to accomplish. We can’t all just sit with our money in a vault, Scrooge McDuck style.

Scrooge McDuck

Not your emergency fund.

Why not just use a credit card?

But saving up tens of thousands of dollars is, let’s be honest, hard. And couldn’t you use that money for other purposes? It can be tough to have money in the bank and not want to repurpose it.

In that case, one might think that not bothering with the emergency fund might make sense, and instead relying on a credit card.

The reasoning might be understandable, but it’s flawed. Very flawed.

Let’s say you have a $10,000 emergency. And you have a credit card with a $10,000 limit and you use it. Emergency solved!

Or is it?

Remember, the biggest risk to using a credit card is that you haven’t paid for anything yet when you use it. The payment is just shifted. Instead of needing a $10,000 payment now, now you have $10,000 balance on a credit card. Which too will need to be paid off.

With interest.

Now granted, you have bought yourself some time. The $10,000 doesn’t need to be paid back at once. Credit cards usually have a 1-3% minimum payment, so you’d only need to pay $100-$300 each month. Which is bad, but perhaps a bit more manageable than $10,000.

The problem here is that you’ve bought yourself time…by spending money.

Credit cards don’t lend money for free, you know. The average APR for a credit card these days is around 14%. If you pay $200 a month on this debt, it’ll take you about 75 months (over 6 years) to pay it off. And you will have paid over $15,000 in the process.

It’s hard to argue that that’s a superior way of paying for a $10,000 emergency. It requires less planning, sure, but at the expense of time and money.

You’d be better with the emergency fund.

Why not just borrow against your home?

(This one is for homeowners only.)

Let’s up the ante a bit. We know that credit cards charge a high interest rate. Why not just get a home equity line of credit (HELOC) for these moments? (FYI, this is not the same thing as a home equity loan.)

A HELOC is sometimes referred to as “a credit card which is secured against your home”. They usually have lower interest rates than real credit cards, so that might make them seem appealing.

But let’s stop and read that word “secured”. You can read that to mean: if you don’t pay it back, you can lose your home!

A credit card, by contrast, is “unsecured debt“, meaning, that if you don’t pay, they can hassle you a lot, but they can’t take anything away from you.

So you traded one problem (high interest rates) for another larger one (home insecurity). That’s way worse.

But you’ll never miss a payment. Oh no. You’ll never get behind. Right. Just like you’ll never have a $10,000 emergency.

Emergency fund wins again

Emergencies are when you need debt the least. You go from having one problem to at least two.

And there is simply no better way to manage a financial emergency than by having an emergency fund. Yes, it might seem a challenge to build up that much money, and then another challenge to keep from utilizing it, but when disaster strikes, you’ll be glad you did. No need for a gas card.

But enough about me. How do you plan to handle your emergencies?

Mike Pumphrey

Mike Pumphrey

I'm the founder and author of Unlikely Radical, a site to help people succeed with money, achieve their goals, and live intentionally.

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Mike Pumphrey
Posted on September 11, 2017
  • Heidi Savell

    This post is well timed, since lots of people are facing (real) emergencies all over the state and country.
    I have an emergency fund (yay!) but I’ve got another question related to emergencies…I’ve been looking into disaster planning recently and have seen people suggesting that I keep some cash set aside in an emergency kit. What do you think about doing this? I see pros and cons. And if you think it’s a good idea, how much should I keep in my kit?

    • Congrats indeed on your emergency fund! That’s a huge step.

      I think the most important consideration to figure out is: what is your emergency kit designed for? What is its scope and duration? Is it just a basic supplement (water, flashlights, batteries), or is it designed to be a self-contained living situation (all food you’ll need). How long is it supposed to last?

      Having some cash seems good to have if there are widespread power outages, where your debit card becomes as good as a paper airplane.

      I think having $100 or so in small bills (per person) will be sufficient to cover basics over a short period of time. Maybe a little more if you want to plan to travel out of the area. I don’t recommend keeping thousands of dollars, in the same way that I don’t recommend planning for the apocalypse. If we get to that point, cash will be the least of our problems.

      Because emergencies are so personal and emotional, the size of an emergency fund is also personal and emotional. (I’ll note that the “Build a kit” page at https://ready.gov/build-a-kit is quite vague on the issue, probably for that reason.) So you should have on hand what makes you feel more at ease. But I think it’s best to first plan how long you will expect to rely on this cash, and what you plan to spend that money on.

      Hope this helps.