Credit vs. Emergency Savings

Having credit and emergency savings is a good idea.

Life comes at you fast, and you just never know when you’ll be in need of funding. For instance, your car might need a replacement part, and car parts can be expensive. If you have credit or emergency savings, you can cover this expense. If you have both, even better because you have options.

But which option is the best?

Let’s compare and contrast:

• You have to be approved for credit; most savings accounts don’t require an approval process, especially if you already have a checking account at the same bank.
• Credit is limited and you only have a certain amount within your credit line; the amount that could be in your emergency savings account is unlimited.
• Some credit lines have an annual fee; there’s a monthly maintenance fee on savings accounts, but these fees can be waived under certain conditions.
• For any credit you use, you will have to pay interest on it (unless you pay the principle amount before a given due date); you can earn interest on your savings (but it won’t be much).
• Having a line of credit could either build or destroy your credit history; savings accounts have no bearing on your credit history.

Let’s examine how they operate:

• Credit is a set amount of funds that you can use over and over again. It’s basically “recycled” money. When you spend with credit, you end up owing a balance and cannot re-use this credit until the balance is paid. When you pay the balance, you can make purchases again. You can pay the entire balance, or pay in installments, but if you pay in installments, you will be paying more than what you ‘borrowed’ because the unpaid balance acquires interest. Balance information (including payments and missed payments) are reported to the credit bureaus and affect your credit score.
• When you spend your emergency savings, it’s gone. Like credit, you can put money back into the account, but you don’t owe that money, so essentially, there’s no rush to put it back. In fact, depending on the emergency purchase, you may never put it back, and if you do, it’ll be over an extended period of time. You can earn interest on your savings, but interest rates are very low for certain accounts so at best, you may only receive a few pennies. There are no penalities as far as your credit report goes.

All things considered, both are great options for a financial cushion. I don’t believe people should have to choose one over the other, but like many financial products, it’s best to opt for what’s right for you.