When it Comes to an Emergency Fund, Cash is King.

The Dough Roller, or DR, is the writer behind The Dough Roller a blog about money management. DR covers how to make more money, how to manage money smartly, and how to invest money wisely. If you like what you see, be sure to subscribe to The Dough Roller

You’ve probably heard the rule of thumb to keep at least three to six months of cash in an emergency fund. It’s often that emergency fund that keeps many from living paycheck to paycheck. But instead of a cash emergency fund, some take comfort in the fact that they have available credit. I confess that at times my emergency fund was near zero because I had so much available credit on my home equity line of credit. Others rely on credit cards that have a cash advance offer they could use in a pinch. Relying on credit for an emergency fund could be a big mistake, and here’s why.

Last week the Boston Globe reported that credit card companies could slash up to $2 trillion in available consumer credit. As the Globe explained, “drowning in debt and soured investments, lenders are seeking to stop consumers from running up big balances in hard times, bills they might not be able to pay.” And the cutback on credit is not limited to credit cards. Home equity lines of credit are also feeling the squeeze. If you dig through your files to find your home equity agreement and read it, you’ll see that the bank can reduce the limit on your home equity line of credit.

My home equity line, which is with Wells Fargo, has this provision that caught me eye:

We may refuse to make additional extensions of credit or reduce your credit limit if:

  • The value of the dwelling securing the line declines significantly below its appraised value for purposes of the line.
  • We reasonably believe that you will not be able to meet the repayment requirements of the line due to a material change in your financial circumstances.

In other words, if we fall on hard times financially, or if the housing market declines significantly, our credit lines could be reduced. And that is exactly what is happening to families everywhere.

To make matters worse, as available credit is restricted by credit card companies and banks, your credit score could take a dive, too. There are several factors that go into calculating credit scores, one of them being the amount of available credit you have used. As credit limits are reduced, the percentage of credit used goes up, even if you haven’t borrowed any more money than the month before. Fair Isaacs, the company behind the FICO score, is looking into this phenomanon and may make adjustments to its credit scoring model next month.

These recent trends underscore why, when it comes to an emergency fund, cash is king. There is one downside, however, to keeping an emergency fund in cash–interest rates. With the Fed Funds rate at near zero percent and Treasurys at historic lows, many savings accounts are paying next to nothing. Still, with FDIC insured accounts safe for up to $250,000, it really is the best option. If you want to make the most of your money, onling banking is the best option. My Two Dollars has written about where he keeps his money, and for cash, it’s ING Direct. The Orange Account currently sports a 2.4% interest rate with no minimums. While it would be nice of savings interest rates where higher, it sure beats relying on a credit card.

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  1. Craig says:

    Right now I keep my savings in my brick and mortar bank and have very low rates. I am thinking of moving it to one of the online banks to get at least a higher rate.