When you’re facing a large, unexpected expense and you have an emergency fund set aside, you might wonder: Should you dip into your savings or pay with a credit card?
The right choice likely depends on a few things, including: how much you have in your emergency savings account and the interest rate and rewards of your credit card accounts. But first you need to determine if the surprise expense qualifies as an emergency in the first place.
What’s an emergency fund really supposed to cover?
An emergency fund helps you pay for unexpected costs that may throw off your monthly budget. It’s very important to have some recourse other than going into debt when you are facing an unexpected expense. A good rule of thumb for an emergency fund is: Build up enough savings to cover three to six months of expenses.
Once you start growing your emergency fund, it can be difficult to ignore money that’s sitting in your bank account. In order to protect your emergency savings from an overwhelming urge to spend it on something other than an emergency, it’s important to make some clear rules for when you will use your emergency money.
There are a few situations that usually constitute a financial emergency, including:
• job loss
• medical emergencies (this includes your pets)
• car repairs (particularly when your car is your primary mode of transportation)
• emergency home expenses (such as a leaking roof or flooding basement)
If you have an expense that doesn’t necessarily fit clearly into one of these categories, consider asking yourself the following questions:
• Is it an unexpected expense? You may feel like your spouse’s birthday sneaks up on you, but it happens once a year and you should budget for presents in advance instead of taking cash out of your emergency fund.
• Is it an absolutely necessary expense? Repainting the siding on your house because you’re sick of the color probably doesn’t count as a necessary expense, but fixing the leaking gutters probably does.
• Is the expense to cover an urgent need? Typically, if it’s something that can wait, such as a new couch, you should save up for the expense instead of pulling from your emergency fund. But if you need to have knee surgery sooner rather than later, that’s an expense that could come from your savings.
When should you consider using a credit card?
If you have a substantial emergency fund, you may want to avoid debt as much as possible. But the reality is that most people don’t have thousands of dollars stashed away to use for their spare tires. In fact, a 2015 study from Bankrate found that only 38 percent of Americans have enough cash set aside to handle an emergency room visit or an unexpected car repair.
If you don’t have enough saved up yet, or if you’re tempted to build up some miles or rewards by using your credit card, consider the following:
• The interest rate of the credit card. If your credit card carries a high interest rate, you may pay a substantial amount in interest if you carry a balance from month to month. If that’s the case, a good rule of thumb is to try to pay off the debt as soon as possible. Consider whether the expense is temporary and whether you can pay the balance in full by the end of the month to avoid interest charges altogether.
• The rewards offered by the credit card. If you get rewards for certain credit expenses, such as gas or travel, using a credit card may actually help you gain extra cash or points. You may want to compare the amount of interest you gain from leaving the money in a savings account against the money you could earn from a rewards credit card. If you’ll gain substantially more from the credit card, it may make fiscal sense to route large payments through your credit card account—if you can pay off the balance at the end of the month. If not, you’ll have to factor in the amount you will owe in interest, which will diminish the value of your rewards.
• Your track record with credit cards. If you are typically able to pay off your credit card accounts on time every month, using your card may allow you to get an airline ticket at the cheapest price and then clear the debt after payday. But if you have a hard time keeping up with your accounts, you may not want to risk a late payment or fees that can result from irresponsible borrowing behavior.
If you don’t have an emergency savings fund, consider starting one this month. Make it a priority to help protect your finances and your family from situations that are outside of your control.
Diane Moogalian is vice president of operations for Equifax Personal Information Solutions. Prior to joining Equifax in 2007, Diane held several strategic roles with leading financial services companies.
The information contained in this blog post is designed to generally educate and inform visitors to the Equifax Finance Blog. The blog posts do not give, and should not be assumed to provide, personalized tax, investment, real estate, legal, retirement, credit, personal financial, or other professional advice. Before making any financial decision, you should always consult with the appropriate professionals who can explain your options, rights, and legal responsibilities, and advise you on any tax, legal, credit, or business implications that may result from those decisions. The views and opinions expressed by the authors of blog posts are their own views and may not be the views or opinions of Equifax, Inc. and/or its affiliates.