How to protect your credit card from emergencies
By Tim Sullivan
When a costly emergency strikes, is your first instinct to pull out your credit card? If so, you may want to consider the benefits of building an emergency fund.
Creating an emergency fund is a vital step toward becoming a responsible credit card user. A credit card can be the perfect tool for many financial situations, but confronting large, unanticipated expenses isn't one of them. Even if your interest rate is low, monthly interest charges can still add up quickly. But a well-stocked emergency fund can prevent the need to go into debt when sudden events force you to reach for your wallet.
What is an emergency fund?
An emergency fund consists of easily accessible assets set aside -- typically in a bank account separate from your normal funds -- to be used only in the case of an emergency. It's not for movie tickets, vacations or video games. It's only for vital, unforeseeable expenses that are not part of your normal monthly budget.
What counts as an emergency?
Simply put, it's any unexpected, essential expense that your budget can't handle. Whether it's a sudden job loss or an accident that injures you or a member of your family, your emergency fund is there to help you cope with difficult times.
I once used my emergency fund when my employer went under. It got me through the next month or so until I started a new job, and saved me from paying my interim costs later with interest. A friend of mine once had a sudden visit to the ER in the early hours of the morning with a ruptured appendix, and spent nearly a year paying off her deductible and hospital fees. An emergency fund would have come in handy for her then.
How much do I need to save?
It depends. Your amount should be determined by what suits you and your situation. While some experts say that three months of normal expenses is sufficient, others recommend six months or more. Take a look at what your usual monthly output is, as well as the minimum you would feel comfortable surviving on, and decide what you will need from there.
How do I get started?
Your emergency fund should be easily accessible -- but not so accessible that it is a temptation. I have my emergency fund in a high-yield online savings account. I don't carry the debit card linked to the account in my wallet, so I can't follow the whim to put an overly expensive dinner on it.
Even if you can only set aside a small amount at first, make that deposit and make a commitment to grow it with each paycheck. Set up an automated transfer from your checking account to make things regular. Once you've reached your goal, cancel the automated transfer -- or consider transferring it to your retirement fund or another savings goal -- and let the account sit for when an emergency comes your way.
What about my credit card balance?
Even if you owe a balance on your credit cards, building an emergency fund can still be a sensible move. Although it may seem more financially intelligent to pay off credit card debt before establishing an extra savings fund, building an emergency fund may help you avoid digging deeper into debt when problems arise.
Particularly in the case of health-related expenses, many emergencies can end up being even more expensive in the long run if they're paid for with credit. For that reason alone, you're likely to rest easier knowing that if the unexpected occurs, you'll have more than just your credit card to cope.