Your furnace dies on a cold February evening. Your car breaks down in the middle of your morning commute. Your dishwasher sends water streaming across your kitchen floor.
These are all big, unexpected expenses, and you don’t have enough cash to cover them. You do, though, have a high enough limit on your credit cards to pay for a replacement furnace, car repairs or a new dishwasher.
There’s a problem here, though: Financial experts say that using credit cards for financial emergencies is a terrible money move. Credit cards come with high interest rates. Using them for big purchases can damage your credit score. And once you get in the habit of paying for big emergencies with plastic? It might be a hard one to break.
This is why financial planners advise their clients to build an emergency fund. Paying for big expenses with a check or cash is far preferable to putting them on your credit cards.
“Credit cards are not designed to use for emergencies,” says Howard Dvorkin, founder of Consolidated Credit and the author of “Power Up: Taking Charge of Your Financial Destiny.” “It’s like using a hammer to do a screwdriver’s work. Something’s going to get broken, and in this case it’s the consumer’s finances.”
The biggest problem? The high interest rates that come with credit cards. It’s not unusual for a credit card to have an interest rate of 18 percent or more. If you put a $1,000 charge on your credit card and you don’t pay it all off when your next payment is due? Those high interest rates can make that initial charge grow every month.
Even though consumers most likely know this, that doesn’t mean that they still don’t turn to credit cards to handle unexpected emergencies instead of pulling from a savings account.
“It happens too much,” says Vickie Hampton, department chairwoman of Texas Tech University’s department of Personal Financial Planning. “Of the more socially accepted forms of credit that people use, credit cards are one of the most expensive ways to borrow money.”
Using a credit card for emergencies isn’t the real problem, says Kevin Gallegos, vice president of Phoenix operations for Freedom Financial Network. It’s what happens afterwards that causes the true financial damage.
“The problem with using a credit card — for any reason — is not in using the card for payment,” Gallegos says. “It’s when the cardholder can’t pay off the bill on time and in full at the end of the month. The interest and fees start to add up. That initial purchase then becomes much, much more expensive.”
Here’s an example that Gallegos uses: You charge $1,500 on a credit card with an interest rate of 19 percent. If you pay make only the required minimum payment each month, and your minimum payment is only 4 percent of your card’s outstanding balance, it will take you more than seven years to pay off that debt. You will have paid more than $889 in extra interest. And that’s if you charge nothing else on that card.
Then there’s the damage that using a credit card to handle financial emergencies can cause to your credit score. Lenders use your credit score to determine whether you qualify for loans and at what interest rate.
One of the factors that determines your credit score is your credit utilization, the percent of your available credit that you are using. If you charge a $2,000 emergency, you’re suddenly consuming a larger percentage of the credit available to you. This can cause your credit score to take a tumble.
Finally, using credit cards for emergencies can quickly become a crutch. Dvorkin says that some consumers have expanded their definition of emergency to absurd levels. He points to clients who used a card to buy their son a suit for his prom. The clients considered that an emergency. Then they had a real emergency: Two weeks later, their water heater blew and they didn’t have any credit available to handle it.
Hampton said that using credit cards is simply too easy. If you had to go to the bank for a loan every time you faced a financial emergency, you might instead focus your efforts on building an emergency fund. But it’s easier to whip out your credit card whenever an unexpected expense pops up, she said.
“And then it’s easy to keep pushing off paying back the money you’ve put on your card,” Hampton says. “You can keep paying that minimum payment, even though you are hardly paying anything off. It can be easy to ignore that.”
The better solution? Consumers should build an emergency fund that they can readily access in case of unexpected financial emergencies. Ideally, consumers should build a fund that can cover six months of their living expenses.
This might seem like an impossible goal. But you can start slowly. Each month, try to put away $50 into an emergency fund. As more money becomes available, you can increase the amount you put into the account each month. And only touch this money for true emergencies: Don’t dip into it to cover a last-minute family vacation.
Are there any situations in which it makes sense to use a credit card for emergencies? Yes, but the list is small, Gallegos says. For example, you might face a travel emergency. Say one of your children is injured during your trip. Charging a medical bill on your card might be a necessity, Gallegos says.
Though a credit card isn’t a good choice for an emergency, it is still better than some other options, says Matthew Goldman, chief executive officer of Wallaby Financial in Pasadena, California. Specifically, it’s better than taking out a payday loan, loans that come with even higher interest rates.
“Credit cards do get over-vilified sometimes,” Goldman says. “Yes, it’s much better to have an emergency fund for emergencies. But if you are still building that fund and you don’t have enough in it, a credit card is always a better choice than an emergency payday loan.”