Can enough balance in your credit card replace emergency funds?

Prabhat Kumar, 47, hails from Muzaffarpur in Bihar. His business is still some way off from generating profits. During the pandemic, his wife was in urgent need of hospitalisation as home treatment didn’t suffice. Being admitted to a private hospital for over 15 days, the bill reached Rs 80,000. Kumar didn’t have an emergency fund or big savings as everything was put to set up his business. Thus, he made use of a credit card to pay the medical bills as an immediate solution.

The concept of emergency funds has gained considerable value in the aftermath of the Covid-19 pandemic. Most families hit either by the infection or its effect on the economy had to deal with a sudden financial crisis. A large number of people were suddenly unemployed. Simultaneously, there was a spike in everyday hospitalisation during the second wave of Covid-19.

Importance of emergency funds 

While medical bills kept overflowing, the Indian middle class struggled to pay them to bits. Those without an emergency fund rushed to pay these bills with a credit card. This brings up an interesting question – Should one set aside emergency fund corpus even if they have sufficient limits on their credit card?

The primary purpose of maintaining an emergency fund is to set aside monetary resources for dealing with unforeseen financial exigencies or to meet unavoidable expenses during periods of income loss arising due to unemployment, illness or disability.

Expert views

“While the credit limit available on credit cards can be used to deal with unforeseen financial exigencies, using it for meeting unavoidable expenses during periods of income loss can have negative consequences,” Gaurav Aggarwal – Senior Director at Paisabazaar.com explained.

Unlike an emergency fund which is essentially your savings, the money provided by a credit card is just a loan that needs to be repaid with higher interests. It may be a quick fix but will only add up your debt liabilities in the future. Any form of credit can never replace savings and investments. While the former may provide temporary relief, it shouldn’t be considered a substitute for the latter.

“The answer lies in the name. The credit card is essentially “credit”. You can borrow from it in case of an emergency. However, it is money you need to pay back to the lender, with interest and penalties in case the payment is not made within the stipulated time. In case of a crisis, this can compound your problems as you will have additional liabilities that you need to meet,” said said Adhil Shetty, CEO at BankBazaar.com.

“The emergency fund is money you have accumulated for use in a crisis. You can use it when you need it and replenish it again over time. This helps you in managing your immediate requirements and reducing your liabilities during a crisis. So while a credit card balance can never take the place of an emergency fund, it can serve as a very useful tool to make payments that your emergency fund can cover,” he added.

Failing to repay the entire credit card bill by the due date, owing to lack of repayment capacity can attract steep finance charges in the range of 23-49% p.a. on your credit card bill.

Besides, Aggarwal pointed that failing to repay the minimum amount due may additionally attract late payment fees of up to Rs 1,300 per month. Hence, credit card users should desist from treating the credit limit as an alternative to an emergency fund.

“Also, the emergency corpus should be big enough to meet unavoidable expenses like household expenses, rent, children’s tuition fee, insurance premium, EMIs, utility bills, etc for at least 6 months. This amount should be parked in highly liquid instruments like high-yield savings accounts to ensure instant withdrawal. Those comfortable with mobile and internet banking can also park their emergency fund in high-yield bank fixed deposits,” he concluded.