Could a credit card be a good replacement for an emergency fund when you need access to money quickly for an emergency?
If you asked bank executives at Commonwealth Bank of Australia (ASX: CBA), Westpac Banking Corp (ASX: WBC), Australia and New Zealand Banking Group (ASX: ANZ) and National Australia Bank Ltd (ASX: NAB) I'm sure they would say yes.
What's so good about an emergency fund?
You never know when an emergency is going to happen, that's why it's an emergency.
Having some cash set aside means that you can instantly cover certain problems. I think every adult should have at least $1,000 set aside in an emergency fund. It's a generally accepted rule that households with important obligations and liabilities should have an emergency fund of three months to six months of living expenses set aside as cash.
You can even put the cash in a high interest savings so it even earns you a little bit of money.
So, what about a credit card?
A credit card's limit could be set for $1,000, $5,000 or whatever the number you think you could need in an emergency. Perhaps the price of up to a replacement second hand car.
Rather than having thousands of dollars sitting there in an account hardly earning anything, it could be invested in shares earning a lot more than 2%. On paper that definitely sounds better.
Think about it. You have an emergency like needing a new fridge – if you use your emergency fund the first thing you'd do is replenish the emergency fund. If you used a credit card to pay for the emergency then you'd pay that off first before anything else. You get back to the same situation very quickly of your emergency fund/emergency credit limit. You just have to make sure you don't use it for non-emergencies!
Of course, the problem would occur if you weren't able to pay off the credit card straight away. That could mean you're exposed to interest at a rate of close to 20% – ouch! That could be a negative spiral that you can't get out of.
Foolish takeaway
I don't have a credit card and I don't have a plan on getting one, but I can see why some people have set up their finances in this way. There could be a risk that the bank won't let you borrow money just when you need it most.
