Emergency Funds Could Save Your Credit Score

blog-emergency-fund-from-comparewalletFICO® Scores can take a hit from any direction, and many times it can be avoided if you think ahead. Performing simple, 5 minute tasks can aid in making sure you don’t miss a payment, such as setting up calendar reminders every month or automating the payments each month to be withdrawn from your bank. Some consumers even ignore payment requests and reminders, naively thinking they will just disappear or won’t affect their score. Two years ago Omar Al Chaar discovered that if you have unpaid parking tickets, your score will drop. Most people don’t know this.

 

What about those unavoidable expenses that pop up? One of the top reasons low and middle-income households in America see a drop in their credit score is due to emergencies. Here are some supporting facts:

  • 40% of households used credit cards to pay for basic living expenses such as rent or mortgage bills, groceries, utilities, or insurance in the past year because they didn’t have enough money in their checking or savings account to cover the expenses.
  • Almost 50% of households carried debt from medical expenses.
  • 86% of households incurred expenses due to unemployment in the past year.
  • 55% of those who claim to have poor credit, state unpaid medical bills or medical debt as a major contributor.

How Emergencies Affect Your Credit 

Let’s face it, you can’t stop that person from rear-ending you while in traffic because he was texting or protect your child from a major sports-related injury; they just happen. For the 76% of us that live comfortably paycheck-to-paycheck, with little or no emergency savings in place, a sudden expense will absolutely cause your score to drop. That means that about three-quarters of Americans are suddenly in debt if an emergency comes their way; a flood, tornado, hospital visit, unemployment, etc.

 

To counter-act missed payments, consumers turn to credit cards as a way to fund their emergency expenses, which is a temporary fix. Applying for a new credit card to transfer a medical bill or to fund everyday expenses in order to get by is just allowing you to move your balances around and delay the inevitable; paying your bill. Furthermore, your FICO Score just took a slight dip because you opened a new line of credit. For the 24.4% (in 2012) of Americans that have scores below 600, an unsecured credit card with a high enough credit line isn’t an option. The best remedy –regardless of your credit score- is planning ahead with an emergency fund.

 

Start an Emergency Fund Today

Emergency funds are one of those things most people don’t think about or put off until next year, or the next, or the next, or…see the problem there? Perhaps other things are more important, such as setting up a college fund or placing additional money into a savings or retirement account. Building an emergency fund takes time and planning. If you’re starting one today, here are a few tips to get started:

  • Look back at all of your bank transactions and bills from the last 6 months and add them up. Exclude items not essential to living –such as cable and high-speed internet- since we are talking about an EMERGENCY fund. That is your new savings goal.
  • Do include semi-annual and annual payments in the amount you should save, such as property taxes.
  • An emergency fund should have about 3-6 months of savings built up to cover basic living expenses, depending on your job security.
  • It’s never too early or too late to start saving.

Some Things to Keep in Mind

The amount needed for your security blanket will depend on many different variables. If you’re single without dependents you may need much less than someone who is married to someone in the same career field, with dependents. I mention “same career field” because layoff’s typically affect the same company or the same industry, such as the recent government shutdown. The risk of both spouses getting laid off is much slimmer for those in separate career fields.

It’s suggested that an emergency fund should be kept in a money-market account (MMA) because it’s not meant to bring in big returns; it just needs to remain liquid. FDIC-insured money-market accounts will provide the biggest returns on those funds. myFICO.com allows you to compare MMA rates, here. Follow the advice in this article to provide a security blanket for your own FICO Score.

 

Sources: Demo’s 2012 National Survey on Credit Card Debt of Low-and Middle-Income Households, CNN Money, FICO Banking analytics Blog, The 250 Personal Finance Questions for Your 20s & 30s, by Debby Fowles (2009), The Wall Street Journal: Complete Personal Finance Guide Book, by Jeff D. Opdyke,

 

Kari Luckett writes about financial topics for CompareWallet.com. Kari is the content strategist for CompareCards.com.

About Kari Luckett

Kari Luckett writes about financial education and personal finance topics. She is the Editor for CompareCards.com. Connect with her on Google Plus, +KariLuckett, or Twitter, @KAL1418.

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  1. […] (been there!). An expensive emergency can completely derail your budget, good spending habits and even your FICO® Score. So instead of being surprised, assume an emergency will […]

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