If you have an emergency fund, congratulations. But when emergencies pile up, should you drain the fund to cover every one of them? It’s a question I asked myself recently after I inherited a car from my mom. While having my own wheels has improved my life, the car has needed repairs that I didn’t plan on.
My emergency fund could have covered the work, but I would have been left without a backup fund to pay my rent if I lost my job. Fortunately, I had a credit card with a very low balance. Plus, it had a sufficiently high credit limit to cover the repairs without hurting my credit score.
Loans you can live with. If you know you will need cash for something coming up-such as new tires for your car-you can apply for a credit card with a zero percent promotional interest rate that lasts for the first 12 to 18 months. For example, the Chase Freedom Unlimited Visa rewards credit card currently offers a 0% annual percentage rate on purchases and balance transfers made in the first 15 months. The Wells Fargo Reflect Visa doesn’t charge interest for the first 18 months, and that can be extended up to three additional months if you’ve made on-time minimum payments. Once approved, you could pay your unexpected bills and make a plan to pay off the balance. To qualify for either card, you need to have a good-to-excellent credit score-at least 670, according to FICO, which provides the credit score most lenders use.
But because you can’t plan for most emergencies, applying for a credit card before you need it is a good idea. It could also help you establish good credit. Just make sure you’re using your card enough to prevent the issuer from closing the account. One strategy is to put a monthly bill-one for a service such as Netflix or Hulu, for example-on autopay and pay it off on time and in full every month.
If you don’t want to go the credit card route-or you don’t qualify for a credit card-a Roth IRA can also provide a source of emergency funds. Because the account is funded on an after-tax basis, any contributions you’ve made can be withdrawn without taxes or penalties.
Another option is a loan from your 401(k) or other employer-sponsored retirement plan. Currently, the interest rate on most 401(k) loans is 4.25%, and you can borrow up to 50% of your vested balance or $50,000, whichever is less.
However, a 401(k) loan could jeopardize your retirement security. The amount you’ve borrowed won’t be invested, and some plans prohibit participants from contributing while they are repaying a loan. And if you leave your job-or are laid off-you must repay the loan by the due date of your tax return for the year when you leave your job (typically April 15, or October 15 if you filed for an extension). If you don’t repay it by that deadline, it will be treated as a taxable distribution; you’ll also owe a 10% early-withdrawal penalty if you’re younger than 59?.
Finally, there’s the bank of Mom and Dad. But if you borrow from that institution, write up a repayment schedule that includes the amount of interest you’ll pay. The upside for your parents is that, with most savings and money market accounts paying less than 1%, even a low-interest loan to you will probably beat what they’re getting from their bank.