Who doesn’t love a high-flying trapeze act at the circus? To watch performers fly through the air, tumbling effortlessly in a choreographed set of flips and twists into the waiting arms of the large man hanging by his knees ready to catch them . . . It’s exhilarating! But it can also be nerve-racking—that is, until you see the safety net spread out beneath the performers.
Whew! That safety net takes away a lot of the concern you might feel for the performers. After all, you think, they won’t get hurt with that safety net in place.
When it comes to our money, many of us like the idea of a safety net providing some measure of security for life’s flips and twists. But the net we’ve chosen—credit cards in many cases—has some huge holes in it.
Millions of Americans are afraid of what might happen financially if they didn’t have one or more credit cards just in case of emergencies. (After all, that’s the only thing they would use a credit card for, right?) When life flips them financially, they fall right into the waiting arms of that little plastic card—their safety net.
But that safety net comes with a cost. If you are really only using it for emergencies, you need to understand the costs associated with that decision. Here are some costs you can expect if you’re using your credit cards as a safety net:
While most credit cards no longer charge annual fees (at least in the first year), almost 25% still do. Those annual fees can range from $15 to several hundred dollars each year.
This is where credit cards make their money. Interest rates can range from 10–23% annually and generally make up about half of your minimum monthly payments. And, if you fail to make your payments on time, you can be charged a penalty interest rate just under 30%. That would be like throwing three dollar bills out your car window for every $10 you owe!
This is where the cost of using credit cards as a safety net really adds up. Why? Because credit card companies know most of us will just pay the minimum monthly payment. After all, who wouldn’t choose to pay $15–30 per month instead of hundreds? But, if you purchase a new computer for $1,000 on credit and just make the $30 minimum payments, you could end up paying more than $1,900 for your computer. And you’d still be making those payments long after your computer became obsolete.
Studies indicate that people spend more money using credit cards then they do with cash. That means higher credit card balances, more interest, extended months of minimum payments and higher overall costs.
That is an expensive safety net!
So what’s a better safety net? An emergency fund—cash in the bank. That’s right! This is one of the main reasons you will hear us talk so much about having an emergency fund that’s easily accessible when you’re facing an emergency.
Building an emergency fund comes in two stages. The first and most important stage is to get $1,000 in the bank as quickly as possible. This money will help you pay for most unexpected expenses like car and home repairs, dental or health emergencies and other small things life throws at you. Instead of turning to your credit cards to bail you out, you’ll have the cash in your emergency fund to cover these emergencies.
The next stage is to save up 3–6 months of household expenses for a fully funded emergency fund. For most families, this amount will be somewhere between $10,000–15,000. With this cash cushion, you can survive a job loss or a health situation requiring your full medical insurance deductible. These big expenses can set you back years and years if you finance them with a credit card.
If you really want to experience a sense of financial relief in this high-flying world, you definitely need a safety net. Just make sure you have the right kind of safety net—a fully funded emergency fund. After all, wouldn’t you rather fall into a pile of cash rather than plastic?