Is a credit card a good replacement for an emergency fund? Commonwealth Bank of Australia (ASX: CBA) and Westpac Banking Corp (ASX: WBC) would certainly say yes.
The sad reality is that a number of people get trapped into a cycle of not fully paying off their credit card and then being charged a high level of interest. So, for a lot of people, a credit card is not the answer. Holding $1,000 or more as cash as an emergency fund might be a better idea.
But, there are a few instances where having a credit card as a backup may actually make sense:
Invest the cash
Cash sitting in the bank, particularly these days, isn't earning much in the bank. It might be better to invest the cash. Would you rather your money earn 2% in the bank or 10% over the long-term from shares?
If you always had an untapped $10,000 credit limit, rather than a $10,000 cash emergency fund, and you would pay off the credit card as soon as an emergency hit (compared to rebuilding your emergency fund straight away too), then, on a spreadsheet comparison, investing the cash could be a better choice.
Of course, there's a danger the bank wouldn't give you the $10,000 when you needed it most.
Backup cyber protection
If your only way of spending money is through a single debit card account then if you were ever a victim of someone accessing your account and (temporarily) steals your money then you would have no way to actually spend money at the supermarket, on your phone bill, your energy or any other imperative bill, particularly if you have to cancel your card until you can get a new one.
Having an unused credit card with a different financial institution could be a useful backup. I myself was a victim of account theft around a decade ago.
You don't have cash yet
Perhaps you have actually committed to building your emergency fund to a large target, such as three months of living expenses, but you haven't built up the funds yet. It would be terrible for an emergency to happen before you're equipped to handle it.
Having that credit available could be useful as a backup until you have the cash in place for an emergency.
Foolish takeaway
For the vast majority of people, credit cards are not the answer. A cash emergency fund is the best way to go. But, in certain limited situations, credit cards could be a useful backup.
