I’m featuring a post today by Plonkee, who is the author of Plonkee Money, a personal finance blog with an English twist. 
Plonkee’s focus on finance is pretty similar to mine as she focuses on behaviorial finance: “thinking about why I and others do things in a certain way - including those times when it’s not exactly the best way.” Her blog is uniquely pink ;), with lots of lively discussion and attitude, and definitely fun. So head on over there and subscribe to her feed if you haven’t already!
My preferred strategy for dealing with an emergency is to whip out a credit card. There are a few reasons for this. Firstly, although I do have a cash reserve in a savings account that I can use for an emergency, it’s in a postal access account. The sort of complete emergencies that I might have (like for example, being flooded out of the house) probably couldn’t wait a week or ten days for the cheque to come from my savings account, until I paid it into my main account and it cleared.
Using credit cards in an emergency means that you’ll have instant access to money which you’ll only spend exactly as needed. You won’t have to estimate how much an emergency is likely to cost at the time when you are least likely to do so rationally. If you tend to underestimate, then you could run out of money, and if you tend to overestimate then you would lose money in interest.
Finally, I have access to a much higher credit limit than I do savings. Through a combination of 4 credit cards and two overdraft facilities, I can access credit equivalent to more than half my gross annual salary. I think this is a good thing. In a genuine emergency, you’re going to have to pay whatever it takes, even if it puts you into debt. For this reason, I prefer to be well covered, especially as some of my most likely emergency situations involve having to buy expensive flights home from whatever exotic country I’ve decided to travel to. As long as you are spending less than you earn, you will pay the debt off if the emergency ends up costing more than you have in your emergency fund.
In most emergencies, money isn’t the focus of the situation, “something else” is. You want to be able to put all your efforts into dealing with that “something else,” rather than making sure that your finances are in place. Easy access to credit that you don’t normally use means that you can use your money as a tool and concentrate your mental resources on the problem at hand.
Image Credit: Piper Report
Your approach definitely requires much self control. You need to be very aware of your spending habits and how you will use that cash. Also you need to be able to reasonably predict your future financial ability to repay the debt. This isn’t always ideal when in the middle of an emergency.
So I agree that it will work if you already have the ability to control yourself, you need to have great ability.
In my opinion when you have an emergency it is the worst time to go out and borrow money. Any time you borrow money you increase risk. Let me say that again, any time you borrow money you increse risk. Borrowing money amplifies emergencies and mistakes. You don’t want to increase risk when you are already in a risky situation.
What if you max out your credit cards and then another emergency comes along, for example you loose your job? Now you look up and you are stuck with the debt and limited ability to repay it.
My statement is general. It really depends on what constitutes an “Emergency”. I haven’t had any emergencies where I had to go out and use a Credit Card. I find other ways to get the money without going into debt. Sell something, or get an extra job for example. I’m a big fan of selling something and sacrificing to get it done, it’s all about motivation.
What if I told you you had to come up with $5000 in 6 months to save your child’s live. You can’t borrow money to do it.
Could you figure out a way to come up with the cash? Very few people will say they can not.
You’ll find a way other than borrowing money, it’s about how motivated you are.
There really aren’t many emergency’s that force you to use your credit card, it’s a choice.
If there is a medical emergency for example you would owe the money to the hospital and you can negotiate with them, you don’t have to use a Credit Card.
My emergency fund needs to be very accessible, I can get the money in less than 24 hours. (Actually I have a Debit Card I can use) I think the whole reason to have an emergency fund is to have it easily accessible. It’s not an investment after all so I have it in a Money Market Account that’s giving me 4.88% right now.
Anyways you make a great point.
I agree! Credit cards are excellent for emergencies and good to fall back on when you’re in a temporary money crunch. It’s not for everyone though, particularly those can’t handle credit and having to pay them off quickly.
-Raymond
You’re right that there’s often a tradeoff between a readily accessible cash or liquid account and perhaps the rate of return you can receive from it. The more accessible something is, the less likely it is that it earns a decent amount of interest.
However, I offer a scheme to make things work out favorably when an emergency hits:
Firstly, I consider myself fairly conservative in terms of investments and financial management so personally, I have more than 6 months stashed away for emergencies. I have the funds in a tax exempt money market fund that returns an equivalent 5% - 6% taxable interest.
I agree, the funds may be out of the way when that emergency hits, so I would probably use my credit card first for that sudden need for cash , then immediately funnel my emergency fund in the next few days and *pay off* the credit card balance right away (like within the few days it takes for me to transfer the money from the emergency fund to the credit card account). That way, credit can be used right away but the emergency fund is the true backup that helps you avoid the cost of using credit.
I have a ladder of emergency funds. First, I keep some money in my checking account. It does earn some interest (MRA account from BofA) but not much, around 2%. So I only keep around $5000 there. That covers any immediate emergencies and it also eliminates the need to juggle funds to pay bills.
For any true emergency, I have a line of equity on my house from which I can transfer money to my checking account in under 24 hours, plus several months worth of pay in an ING account. I’ve never used either and I’m very careful with them. The equity line is too tempting for some people so unless you can really control your spending, I would recommend against it.
Gal
Thanks for including my post.
One of the issues that I have is that it probably takes about a week for me to access my emergency fund. I can think of lots of possible emergencies where I can’t wait that long.
An emergency when I was overseas would go straight on the credit card. There simply wouldn’t be any other way to get the money quickly. Similarly, if one of my family was in some sort of accident, I’d put the train tickets on my credit card and sort out the emergency fund money later.
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In a genuine emergency, you’re going to have to pay whatever it takes, even if it puts you into debt.
I’m not sure I understand this. Some people literally are unable to “pay whatever it takes” - the only credit available to me is $100 in payday loans.
What5 happens when someone CAN’T pay whatever it takes in an emergency?
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If you use a credit card to pay for a large expense but you have enough cash in savings to cover it - that’s not going into debt - you’re basically using a credit card as a payment method, which is totally fine.
But if the question is - if you have an emergency and have to use a credit card to go into debt temporarially, again, I think a credit card is totally acceptable if you have the ability to manage said debt - meaning regular dispoable so you can quickly come up with a payment plan to pay it off as quickly as possible.
But to be honest - I could think of some situations where taking on the credit card debt could be extremely risky - say you’re maxed out on cards or don’t have any savings to fall back on. I really have no answer for that one!
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I’d like to see something on the “cost” of NOT having credit for emergencies.
That is, compare what it would cost a person without credit in the long run (including opportunity costs, such as the wages lost when your car breaks down you can’t get to work and you can’t afford to fix it until payday), with a person who has sufficient credit to promptly deal with emergencies.
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