One such disconnect revolves around the advice to NEVER carry a credit card balance.
No credit card debt, no problem. It’s abstinence-only financial education. The reality, however, is that lots of us know borrowing against credit cards isn’t wise, but we do it anyway.
- We can’t afford a vacation/dream wedding/remodeling, but we charge it “just this once” and promise to “pay it off quickly.”
- We may have cash, but pay over time with a card that has a 0 percent introductory rate.
- We don’t have an emergency fund, so we charge the repair and pay it off over a few months.
In these cases, overly-simple personal finance is misleading. Yes, if you NEVER carry a credit card balance, you won’t get into trouble. But there are times when credit cards may be an undesirable but necessary part of your financial plan.
Today I want to talk about a unique situation: What happens when hit tough times and you have little or no emergency savings but you do have available credit? Is it ever OK to tap that available credit to make ends meet?
Let’s be clear: This is dangerous territory. If you lose your job and use credit cards to just keep on living your current lifestyle, you’re barreling towards a debtor’s hell and possible bankruptcy. On the other hand, using credit cards carefully is better than going hungry. Let’s look at a few examples.
Using credit cards for emergency expenses if you don’t have savings
In my early twenties, I drove two different old Volvos; great cars, but costly to fix. While I learned to do many repairs myself — from spark plugs to brakes — some required many more tools than I owned. These fixes were at least $500, and credit cards were literally the only way I could pay for them.
If you’re suddenly faced with a large expense and don’t have cash in the bank to pay for it, realize that it won’t be the last time. This is why having $1,000 or so in the bank as a buffer is so important and, ultimately, an emergency fund equal to six months’ of expenses.
OK, but you don’t have that right now. So what can you do? Assuming you can’t borrow from family or friends or work your tail off to raise the funds quickly, you have a few options:
- Overdrawing you bank account. You’ll pay a big fee, tie up your checking account, and risk additional overdraft fees.
- Payday loans. These loans may be cheaper than getting dinged with multiple overdraft fees, but they come with fees that – if annualized – would be an APR of 100 percent or more! It’s easy to get trapped in a cycle of needing another loan just to pay off the last one.
- Credit cards.
The biggest risk of using credit cards is how easy it is to use your card this way every time you have a big expense and then not commit to paying off the balance quickly. If, however, you can pay the charge off in a year or less, the interest expense is comparable to a single $39 overdraft fee. For example, a $500 balance at 15 percent APR paid off $50 at a time would take 11 months and cost $37.52 in interest.
Using credit cards when you’ve lost some or all of your income
It’s one thing to use credit cards for unexpected expenses when you’re employed and then pay the balance off in a few months. It’s another thing if you’ve lost your income, have bills to pay, but have no idea when you’ll be able to start paying off the credit card balance.
As I wrote earlier, when you lose your job or suddenly face a reduced income, you should scale back any debt payments to only the minimum and try above all else to avoid taking on new debt. You may not be able to continue your march out of debt, but at least you want to avoid digging deeper.
But what if you can’t? What if there simply isn’t enough money in the bank to pay the bills each month and put food on the table?
If things get this dire, your first priority should be reducing expenses as much as possible and finding work – any work – fast. You should not be ruling out moving in with family and/or relocating for work.
Beyond that, it may be time to turn to credit cards. Remember, this is truly a last resort. If things come to this, keep a few things in mind:
- Without an income, you can’t get new credit. What you have is what you have. Applying for new credit and maxing out your available limits will lower your credit score further.
- Avoid cash advances. The interest and fees are far higher than purchases.
- Start with the lowest APR first. Avoid using higher APR cards if you can help it.
- Stay current with minimum payments. If you can only make minimum payments while you look for work, make them on time. A single missed payment could cause your interest rate to skyrocket and jeopardize your access to credit.
- Know how long you have. When will you be maxed out? You need to find work and reverse the flow of money onto your cards well before that deadline!
Finally, be aware of the consequences. Using credit cards to finance or supplement your monthly living expenses for a long period of time will have one of two consequences: Either you’ll be responsible for paying off big balances at high interest rates or you’ll need to declare bankruptcy. Neither is good. Either you’ll be in debt for years or you will have to pay a lawyer, sell some of your belongings, suffer through the emotional toll of bankruptcy and, ultimately, rebuild your credit from scratch.
Preparation is the best policy for tough economic times like job loss or illness, but if you find yourself turning to credit as a last resort, do so sparingly and intelligently.
What about you? Have you ever used credit to get you through tough times? What advice would you give?