Beating Broke

Personal Finance from the Broke Perspective

Credit Cards as Emergency Funds

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Everybody knows they need an emergency fund.  Right?  Right.  There’s some argument about how much to keep in your emergency fund, but the general rule is no less than $1000 and ideally 6-12 months of expenses.  And common savings strategies says that you should keep that money in a nice comfy savings account that you can access as needed.  But, let me play devils advocate for a minute here.  Let’s say you had $1000 in your emergency fund.  What could you do with that $1000 if it were freed up and spendable?  What if, instead of having your emergency fund in a savings account, you used a credit card that had no balance on it?

You read that right.  A credit card.

Take you’re average credit card with a $1000 to $5000 credit limit (higher if needed) and keep no balance on it.  You’ve got a ready made source of funds, up to the limit, that you can access from just about anywhere.  And, it frees up your emergency fund savings to pay down debt.  Or invest.  Or, you can still keep it in a savings if you want and just use the credit card to supplement the emergency fund so you don’t have to keep such a high balance on it.

Pros and Cons (My wife likes these lists and always makes me write one when making big decisions…)

Let’s look at the pros for using a credit card as an emergency fund.

  • Cash is freed up for investing/paying down debt.  Why earn 1% on your emergency fund cash when you could be paying off debt that you’re paying 10% or more on?  Or, that you could be investing and possibly earning a nice return on?
  • No balance needed.  The card would be dedicated to the emergency use, so you wouldn’t carry a balance on it unless you had an emergency.
  • Available anywhere.  You can instantly access your emergency fund from anywhere your card is accepted.  Which is virtually anywhere.

Now, let’s look at the cons for using a credit card as an emergency fund.

  • Card could be closed.  If you don’t carry a balance and never need it, there’s a chance that the card company could close your account and you wouldn’t be able to use it when you needed it.  There are ways around that.  You could use it for a specific bill each month and then pay it off just like you would if you were paying the bill normally.  Problems could arise if you don’t pay that balance though and fill up the card.  Then you wouldn’t be able to use it either.
  • Interest charges.  Nobody likes paying interest on anything.  If the emergency is big enough and bad enough that you aren’t able to pay it off right away, you’ll start racking up interest.  That can lead to a quick spiral into the same debt boat that you were in to begin with.  Or worse.

I don’t know if I could recommend using a credit card as your only means of an emergency fund.  But, I think you could make a pretty good argument for using one to supplement your current emergency fund.  Let’s say your goal is to have 3 months expenses in your emergency fund.  And that your expense are $5000 a month.  That’s $15000 that will just be sitting in a bank doing nothing more than earning 1% interest. If you’ve got a card with a $10000 limit on it, you could pare that down to just $5000 in the bank and use the other $10000 to pay off a bill.  Or invest in something.

I think the biggest problem with using a method like this is the potential pitfalls.  If you are unable to keep the card active and balance free, you’ll have problems using it when you need it.  If you do need it and are able to use it, but not pay it off, you could potentially end up in the deep water again.  On the other hand, if you use up a cash emergency fund, you still need to pay it off, but you won’t have to pay interest on the part you used.

Using a credit card as an emergency fund is doable.  But, I can’t suggest it for any but the most disciplined.  One wrong step, and you could end up having more of an emergency than you would have normally if you just had a cash emergency fund.  And that could lead to disaster.

What do you think?

Now, I want to know your opinion.  Would you consider using a credit card as part (or whole) of your emergency fund?  What about using a line of credit as an emergency fund source? Would higher interest rates on savings change your mind? What pros and cons did I miss?

A World of Cash Only

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What if you couldn’t use a credit card.  What if you couldn’t get a loan?  Imagine a world where “credit” as we know it no longer exists.  Or never existed in the first place.  Would that world be better or worse than what we live in now?

visa signatureIn many ways, credit that is used wisely can be a benefit to our lives.  It allows us to get a house without having hundreds of thousands of dollars in cash available.  It allows us a car without having to have tens of thousands available.  I know, if you purchase smartly and within your means, you don’t need hundreds of thousands of dollars for a house and you don’t need tens of thousands for a car.  But, for those that feel that they can afford to pay those payments, credit makes it all possible.

What would a world where there was no credit look like?  Instead of spending our last dollar to pay off the loans we get with our credit, we’d spend more of our time working for fulfillment.  If we didn’t have the ready cash available to pay for something, we’d have to save for it.  Or trade for it.  And we’d do more for ourselves.  We’d mow our own lawns.  We’d do our own handyman work.  Do-it-y0urself tasks wouldn’t be something of a novelty, but more of a normal thing.

For some, it may seem trivial.  What difference does it matter whether I use credit or not.  I’m responsible and pay my bills, they’ll say.  And then, they’ll get up on Monday morning and go to the job that they’ll freely admit they don’t like much, but they keep it because it pays well.  But, if there was no credit, they wouldn’t need a job that pays well.  They probably wouldn’t need any resume tips. They’d have the ability to find a job that they enjoy.  A job that is fulfilling and rewarding.

And that makes a difference.  The stress and turmoil that a job you don’t like can bring into your life is not only unpleasant for you and those around you, it can actually be fatal.  Without credit, keeping up with the Joneses becomes a thing of the past.  You only need to keep up with what skill sets they have that you don’t and find an amicable trade.

Will this world ever exist?  Wholly? No.  There are way too many hands in the pot of credit for it to ever go away.  Too many millionaires made by taking advantage of other people through credit.  But, that doesn’t mean that you and I can’t strive to lead our lives in the direction of no credit. We can take control of our finances through good financial management principles and lead a life as free from credit as possible.  And, it is possible.  Don’t be afraid to dream of that.  And don’t be afraid to guide your finances with intention.

Breaking free from the harness that we’ve given ourselves can lead us to a better life.

photo credit: TheTruthAbout

Obligations of the Buyer

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With all the news lately about people “walking away” from their mortgages, increasing bankruptcies, and debt consolidation/repayment schemes, I got to thinking about what the obligations of the buyer are.  And, also, the ways that we as a society have made it easy to sidestep those obligations.

Obligations

What are our obligations when we buy something?  Does buying a pack of gum carry different obligations than buying a house?  Naturally, we have obligations to ourselves as to the upkeep and use of that which we buy.  If I buy a house, I have an obligation to myself to do what I can to make that house last as long as possible and remain structurally sound.  If I buy a pack of gum, it’s a lesser commitment, but that obligation still exists as an obligation to not let my purchase go to waste and either chew the gum or give it to someone to chew.

What obligations to we have to the seller when we buy something?  There are two ways to look at this.  The first scenario involves paying cash for something.  If the full purchase price that was negotiated is satisfied, I don’t believe you have any obligation to the seller.  However, if the purchase involves debt of some sort, there are obligations that arise.  If you purchase with a credit card, there is an obligation to pay that debt to the credit card company.  The same is true for a mortgage, a car, and even a pack of gum.  Not only do you have an obligation to pay the debt, but you also have another obligation to yourself to learn what that debt is going to cost you.  This last obligation is the one that was most ignored during the fiasco that we like to call a housing bubble.  Many ignored the facts of what their new houses were going to cost and bought them anyways.

Sidesteps

In the pursuit of a consumerist society, these obligations can sometimes get in the way.  If I ignored the obligation to know the cost of debt and bought a house anyways, I likely entered into an agreement to pay a mortgage company a set amount each month.  Recently, it’s become popularized to demonize the banks that lent the money to people as the sole problem and, as a result, it’s become no big deal to merely “walk away” (default, or stop paying) on a mortgage.  The reasoning follows that it’s better to default on the mortgage than remain paying on a house that is worth less than what the purchase price was, or that has had payments adjusted higher.

Bankruptcy OK!In the same way, the obligation to pay credit card bills, auto loans, and most other consumer debt has been sidestepped.  It’s no longer a social stigma to declare bankruptcy.  Many, knowing they are about to file for bankruptcy, will go out and max out their credit lines in anticipation of the bankruptcy cleaning the slate.

As these sidesteps become more and more common, the social stigma will decrease even further.  If everybody is doing it, it’s hard to demonize something.  You might demonize your friend.  Or relative.

Of course, this isn’t to say that defaulting on a mortgage should never happen.  Or that bankruptcy should never be declared.  It happens.  It’s the rampant social acceptance of these situations that is troubling.  What happens when it becomes commonplace for mortgage borrowers to default?  The loans become more expensive.  The banks have to cover their costs to repossess the house, the staff to service the loan, and associated costs with trying to resell the house.  Where is that money going to come from?  They aren’t going to just pay it out of the kindness of their hearts.  They’ll pass it on to the customer.  Suddenly, mortgages will become even more front loaded with fees and interest.  When bankruptcies become more commonplace, credit availability is going to decrease.  We’ve already seen that recently.  People who could easily get a credit card before will be denied.

All of this is all the more reason to avoid debt whenever possible.  If society isn’t going to do it, hold yourself to your obligations as a buyer.  Obligate yourself to paying off your debt.  Then, obligate yourself to paying in cash from then on.

photo credit: EJP Photo