Monday, October 7, 2013

Why Don't you have an Emergency Fund?

These days, you just never know what's coming around the next corner. It might be an auto accident, or medical bills, or even something as innocuous as your child needing a new uniform for their extra curricular activities. These expenses, surprises that they are, can decimate a budget in just one quick sweep! That's why it's particularly important to make certain you have an emergency account that you can tap into so that you can avoid having to pay for those emergencies with credit.

There's a relatively new form of credit out there, that has appeared in response to increased health care costs and decreased insurance benefits. In order to avoid having to decrease prices (why would anyone do that, obviously?) the banks developed something that patients can use to bury themselves in debt for being sick! This is being used to make up for shortfalls between coverage and cost, and it can easily amount to tens of thousands of dollars. Of course, they make it seem like the most natural, useful thing in the world. The problem is that credit like this works much like a store credit card. It's easy to get, and typically offers lucrative financing terms, but there are dangers involved that may make you want to rethink using credit. Like a store credit card, there are times when being just a day late on a payment will cause the loan to default back to the non-promotional apr, which can be nearly 30%!

Unfortunately, auto repair seems to be going in the same direction. Rather than paying cash for emergency repairs, more and more people are depending on credit and paying for repairs for months, rather than just paying out of pocket for them. While you might not really have a problem with this arrangement, it has the effect of raising the price of the repair beyond what you might actually be willing to pay up-front for it.

Let’s consider a $1,000 repair bill to keep the math easy, and further, let’s say you pay for the repair with a credit card that has a 15% purchase rate, and take six months to pay it off. You’ll be paying $174.03 per month for the purchase, and at the end of the six months, will have paid $1,044.18 in total. That’s nearly $50 you paid just for the privilege of paying the balance off over time. Most people would kill for a $50 coupon on their next $1000 (necessary) purchase, so why would you spend that money if you don’t have to?

The argument that you’re probably formulating in your head right now is most likely that of “I can’t afford that.” And, perhaps that’s true. But, let’s think critically for a moment. Unless your car (or plumbing, or other catastrophe) happens to have a problem every month, you’ve probably got a few months between the problems where there really isn’t much going all that wrong. This is when you need to be building up your emergency fund. It’s nothing more than a basic, easy-to-access savings account that you use instead of credit cards when trouble hits. Try this for a while: Start putting back $100 per month into a savings account that you don’t touch for general stuff. In a year (if you don’t touch it, of course,) you’ll have $1200, in addition to the interest accumulated, and you’ll be able to tap that should something go wrong and have a little bit left over, to boot!

In this age of pinching pennies with coupons and cutting deals online, it’s surprising that as many people use expensive credit cards as do. Fortunately, it really doesn’t take much to break that habit, and get on the right track financially!

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