Why a line of credit is not an emergency fund
For years, my line of credit was my crutch. I used every available dollar of credit available to help me limp from month to month, or whenever an “emergency” arose.
Times have certainly changed for me. I just hit the $10,000 mark for my emergency fund – which represents 4 months of comfortable living based on my current needs – or 5 months of living on a bare-bones budget. However, now that I’ve been debt free for a few years, I’m often asked why I don’t use a line of credit as my emergency fund instead – leaving me with the entire $10,000 – which I could invest in something that might earn me more than the 1.50% interest that I’m getting right now.
Some personal finance bloggers believe that a line of credit is the perfect solution to a true emergency. But I’m not one of them. I’m a full believer in having a cushion made of cash, not credit. :)
Here are 5 reasons why I will never use a line of credit for an emergency fund again:
- Savings means having breathing room: Having a cushion allows you the freedom to work through your emergency without having to go into debt at the same time. While it’s true that the money in your emergency fund will eventually run out, the same can be said about a line of credit. The difference is, after your emergency money is gone, you will still be debt-free. And should you need to look into other options for a long-term emergency situation, you will be that much farther ahead.
- Credit lines aren’t savings: The most obvious problem with using a line of credit as an emergency fund is that you eventually have to pay it back. If you are forced to use your emergency fund, then you are clearly in an ‘emergency’ type of situation. Why would you want to face the added stress of piling on debt? If you’ve ever had to use your credit card before to make an unexpected purchase, then you’ve probably experienced the stress involved with trying to figure out how you’re going to pay it off. The same can be said with a line of credit. Don’t think the lower interest rate will be easier to handle than that of a credit card! Debt is debt, and it is stressful no matter how much it ends up costing you.
- The bank controls your credit line: A huge obstacle with using a line of credit is that you are at the mercy of the bank, as well as fluctuating interest rates, and changes to policies and procedures. If your line of credit is secured by your home equity, you have the added pressure of knowing that you will be putting your house is at risk.
- Credit doesn’t offer security: An emergency fund is meant to act as a cushion. If you stumble, it is there to catch you, no strings attached. You don’t have to worry about payment schedules, interest rates, or mounting debt. Relying solely on credit means that you are always living on the edge. Having cash in the bank gives you options. You call all of the shots. Not only will your own money give you a solid sense of financial security, but there is something to be said about the confidence it will give you as well. Knowing that you can handle virtually any situation that comes your way is an empowering feeling.
- Nobody is immune to emergencies: Remember that no matter how stable your job might seem, or how good your health is, nobody is immune to emergencies. And sometimes, you just don’t know how long you will be stuck in that kind of stressful situation.
Being faced with an emergency is the absolute worst time to go into debt. Protecting yourself from life’s inevitable obstacles is a huge part of creating financial security. Having an emergency fund will open up doors for you during a period in your life where you will need all the help you can get.
Would you use a line of credit as an emergency fund?
Author: Krystal Yee
I’m a personal finance blogger and marketing professional based in Vancouver. I’m a former Toronto Star (Moneyville) columnist, author of The Beginner’s Guide to Saving and Investing, and co-founder of the Canadian Personal Finance Conference. When I’m not working, you can usually find me running, climbing, playing field hockey, or plotting my next adventure.