Conventional financial independence wisdom says to have an emergency fund. Could you use a credit card for emergencies?
Like everything on this site, this article isn’t meant to be financial advice. Financial advice is specific to your circumstances and should be given by a professional. This is simply my perspective that you can use or ignore when working on your own financial independence campaign. Don’t trust your future to a random on the internet! Make up your own mind.
This week I signed up for a 0% credit card offer
Yes, I have credit cards.
At the time of writing, I have a balance of £200 on them. I’m not worried: this was a deposit for a hire car that I have now returned, so it will be refunded before I have to pay interest on it.
I’ve had a credit card since I was about 22 and in full-time work. At the time, I was using them to “build up a credit rating“; because, you know, it seemed like the thing to do. That wasn’t a particularly solid plan and I have zero evidence that it had any effect.
Full disclosure: when I was 22 I knew nothing about personal finance, investing, or anything other than “If I have £20, I can spend £10 on food and £10 on beer…”. I’d graduated from university with a ton of debt – not just the student loan, but a hefty student overdraft – and when you’re that far behind the money-making curve you don’t imagine that there’s a world where you can actually make money. Plus, looking back, I was a bit of an idiot, especially when it came to money.
Suffice it to say: when I heard that I needed to have credit cards to build up a credit rating, I believed it.
What I use a credit card for
Fast-forward to today: I now have assets.
My home is reasonable secure, with a sizeable chunk paid off. My pension is looking pretty good and I’m confident of actually being able to retire, which is a more impressive feat for a millennial than it sounds. I have an ISA. My career prospects are looking pretty bright, but I could live as I am for at least a year with no income before I have to change something in my budget.
And yet, I still have a credit card.
I use my credit card for online shopping on websites that I don’t know or necessarily trust. It’s also good for services where there’s a chance that the provider goes bust or can’t perform – for example, for booking flights abroad or any kind of holiday. Finally, I use my credit cards as part of my emergency plans. I’ll explain that last point in more detail later.
I tend to pay my credit card off in full as soon as I can – often the same day as the purchase. That’s because there’s a time period (I think it’s about 50 days on my current cards) before interest starts being applied to the balance, so I effectively pay no money towards the balance but I get the benefits of using a credit card.
That’s not technically true – somewhere in the transaction, a part of the seller’s price will include the fee for using payment services – but I don’t usually get a choice on paying for that, it’s just built into the seller’s prices.
Before I continue, I’m going to do a quick primer on how credit cards can work for you. If you’re already clued-up on credit cards, skip the next section.
How credit cards can work for you generally
“It’s just like a debit card that lends you money, isn’t it?”
Not quite.
When you pay for something using a debit card, your payment service provider (probably Visa or Mastercard) arranges the transfer of money from your account to the account of the seller. It’s a transfer service. You front the cash, the seller fronts the goods, and a contract is made between you and the seller.
If something is wrong with the goods and services, that’s your problem. It’s for you to sort out with the seller. If the seller goes bust, you’ll have to pursue a claim against their administrators/ liquidators for your refund.
With a credit card, things are different.
This time, your credit card provider buys the goods, then sells them to you on pre-agreed lending terms. That’s why the interest gets charged: it’s interest on borrowed for the amount that the card company paid the seller.
This means that there’s one contract between you and your card company, and a separate contract between the card company and the seller. Which means that if the goods you’ve bought aren’t good enough, or the service isn’t performed, you can claim for refunds against your credit card provider.
This arrangement is often referred to as “clawback“. Effectively, if a service provider doesn’t refund you for failing to provide goods or a service, you can report them to the credit card company who will use their powers to recover the money. You get refunded by the card company; the card company gets refunded by the seller (if they can).
As far as you as the consumer are concerned, it’s an extra level of protection, which is a good thing.
When credit cards suck
The problem with credit cards is that if you miss out on the interest-free repayment period, the interest rates are punishingly high. I haven’t been offered a rate lower than 20% at the time of writing, and my credit score is pretty reasonable.
This means that if you get into the habit of paying with a credit card but not getting into the habit of checking your credit card balance, you can get into hot water fast. There’s almost no way that you can earn better growth from £100 in investments than you would need to pay in interest from £100 on a credit card. Oh, sure, it’s possible – you could buy low, sell high and all that jazz – but it’s far from probable.
Mitigation tactic 1: 0% on purchases
This can be offset by introductory offers. The first of these is your classic “0% on purchases” offer.
The offer works by giving you an introductory period – often a year or more – where you don’t pay any interest as long as you make the minimum repayments on the card. These can be quite low.
You run the risk here that if you miss the repayments, then the credit company can withdraw the offer. Now you owe £XX to a credit company at 20%+ interest. Awesome. I reduce this risk by setting up a direct debit from my current account to pay off the minimum repayments of any credit card I sign up to.
Mitigation tactic 2: 0% on balance transfers
It’s possible to hold a balance on a credit card, then open a new credit card and transfer the debt from the old card to the new one. This is called balance transfer, and it’s often something that’s offered at 0% interest for a period, quite often a year or so.
I… don’t do this. It’s not really something I’m comfortable with at the moment, although that might change if there was a cool business opportunity or something. Generally though, this isn’t something I would do.
Again, you run the risk of the offer being withdrawn if you miss a repayment. You also gain some brand new risks.
Firstly, your debt on the old card might be bigger than your new card gives you, in which case you’re going to be paying interest or debt off somewhere.
Secondly, there’s no guarantee that a provider will offer you a 0% transfer period. You might apply and be told “no, not this time, not for you”.
It’s the second risk that puts me off. I’m not willing to take the risk that I would have so much debt that I’d need to do a balance transfer. Which brings me on to the main event of this article.
What I DON’T do
As a rule, I don’t use my credit card to buy something that I’m not planning to pay cash for anyway.
The most I’ll stretch it over is either side of payday. That only happens if I’ve got the cash to pay half up front and I was planning to buy whatever it is in cash after payday. For example, I bought some materials for a garden path a week before payday last year.
I do not and will not advocate using a credit card to buy something you cannot afford in cash, or to delay payments to buy something bigger than you could afford, except in absolute emergencies.
Don’t get me wrong: I’m no saint. In the past, I had a really awesome motorbike that I bought with a personal loan. I loved that motorbike, but guess what – I loved it a lot more once I’d paid the loan off. Which I did as soon as I could, a lot sooner than the bank were expecting.
I’m still sad about that motorbike. I sold it for a commuter car when our situation changed. Don’t ask about it, it’s still too soon.
I wouldn’t do that again, except maybe as part of a deliberate tactic to buy an asset, and only with really cheap debt.
Using a credit card for emergencies
You could use a credit card for emergencies. If you have a card with a credit limit of, say, £3,000, that should be enough to cover the cost of a replacement boiler (give or take). It’s enough to get a really cheap second-hand car if yours completely dies. It’s enough for a rent deposit on a flat in most places in the UK if you suddenly need to move.
Interestingly, this is something that Mr Money Moustache has advocated using. According to Mr Money Moustache, if you’re financially independent, you could use debt instead of an emergency fund. He usually tells his followers to do all their monthly spending on a credit card, then pay it off with income, but the options for emergencies that he suggests are either to sell shares or to use cheap debt.
I’ve embedded this video from his YouTube channel below. I don’t know much about getting a “line of credit” against your house, but the concept is effectively the same: use cheap debt as your emergency cushion to maximise investments which earn an income.
If you’re on a 0% offer, that’s even better. Or is it?
The obvious risks of using a credit card for emergencies
The obvious risk here is that emergencies, by their nature, tend to be unexpected – which can be in both their size and their timing! That’s what makes them “emergencies” rather than “inconveniences“.
As a result, it is possible that an emergency won’t get paid off in the 50 days you expect. This might put you at the risk of paying that hefty 20%+ APR interest fee, unless you happen to have some 0% purchase offer time still remaining and can pay it off before that expires.
There’s also the risk that an emergency is bigger than your card’s credit limit. As Mr Money Moustache’s video above says, selling some assets – like shares – is an option. However, it’s not a fast option: it can take a couple of days for funds to clear in an investment account, so it will be a few days before you can sell up and withdraw the money from your investments.
In an emergency, how long can you wait for the money?
Then there’s the risk that the emergency happens when you’re using it to cover the deposit on a hire car…
The emergency fund/credit card combo
I consider my lines of credit as part of my emergency fund. That’s why I applied for a 0% credit card this week: I like having a cheap debt option so that I don’t need to sell my investments for minor emergencies, and I don’t like having the world’s biggest emergency fund.
It’s not for everyone.
Ultimately, using a credit card for emergencies will depend on your risk tolerance, income, the progress on your financial independence campaign, and your discipline with using debt.
I wrote an article on considerations for emergency funds previously, which you might be interested in.
Our emergency fund is about £4k. That’s based on our job security, cash flows, liabilities and risk tolerance. When we add my 0% credit card, that extends to around £12k. For illustration: that would more than pay my mortgage for a year, without accruing interest. It’s hard to see what kind of emergency, other than the kind that money couldn’t possibly solve, couldn’t be stalled with that while assets and insurance policies are called in; especially as we don’t have a car anymore.
My emergency plan
My plan for emergencies is to use the debt first, with an aim to postpone or reduce investments to clear the balance. That would leave us with cash in reserve. In the event that the balance on the card continues to the end of the offer period, we then have the option of using the emergency fund cash to settle the debt.
This is because the debt is effectively interest free, whereas the savings are earning 0.5% before accounting for inflation. Yes, that’s tiny, but it’s still greater than zero – and I believe in maximising my opportunities.
It’s also the case that I spend considerably less than I earn, so I should be able to clear off a maxed-out credit card within a year.
If all else fails, I could use the emergency fund to assist with the repayments.
This gives me a huge emergency fund capability while only having £4k of capital uninvested.
You probably shouldn’t copy my plan if…
Just because a plan works for me, that doesn’t mean it’s a good plan for you to copy.
I’m not willing to give you financial advice. Certainly, not for free, and certainly not while I’m unregulated. That way lies danger and a knock on my door from the Financial Conduct Authority. However, in general and (importantly!) unregulated terms, it’s probably a bad idea to copy me if:
- You tend to get numbed to spending on a credit card. If you do, you might end up in big debt. That’s the opposite direction to where your financial campaign should be heading!
- Temptation tends to win in your life. Again, having a big credit card opens up opportunities: not all opportunities are opportunities to succeed.
- You have a tendency to worry. I’m not just talking about you being worried about debt on a credit card. That’s also an issue, but it’s not the issue that I’m thinking of. I’m talking about the chance of you classing minor inconveniences as emergencies and using up credit quickly. It’s psychologically harder to spend cash in your account than credit (I don’t actually know why, but the anecdotal evidence from my life experience is too big to ignore), which makes you double-check if everything is a “real” emergency or if you can improvise and make-do.
I probably won’t use this if I become financially independent
My present goal is CoastFI. While I’m accumulating and even when I’m coasting to financial independence, this strategy means that my capital is put into assets wherever possible. It works for me!
When I reach true financial independence, my emergency plan will probably change. I doubt I’ll be given a generous line of 0% credit when my income is based on my asset portfolio!
Using a credit card for emergencies might give way to the fact that I will likely have more time to resolve emergencies myself, as opposed to needing to pay out for them. I’d also expect fewer emergencies. Boiler repairs, roofing leaks and so on, sure; but I could simply factor decent insurance into my ongoing lifestyle costs. My chances of needing an emergency car/bike/aeroplane ticket to get to work will be negligible when working becomes optional. If I get sacked, could I still pay my mortgage? Well, yes, if I were financially independent, I most certainly could. I may not even have a mortgage!
The way I would plan to do this would be to maintain either a cash or (more probably, given interest rates) a government bond buffer, as a relatively safe asset that can be easily liquidated in an emergency if my equities or any other investments have temporarily dipped in value.
Effectively, I’d build up an emergency fund in the traditional way, but I’d do it after achieving financial independence rather than during my campaign. For now, while we have the income from two adults working, we can take the risk with a smaller pot and a credit card for emergencies.
