Debt Myth #2: “Credit is a Safety Net”

Via Flickr, by user snowpeak. Used under Creative Commons License.

If your parents sent you off to college with a credit card, “just in case of emergencies,” they were likely operating under one of the most prevalent beliefs about debt in our society — that credit provides some kind of safety net, in case “something unexpected” happens. Now we’re not here to bash your parents, but the truth is that this sort of thinking actually sets you up to fail financially.

How does the idea of credit as a safety net lead to financial failure? We’ll, let’s start by getting our terms straight: In this case, “credit” really means “debt.” When you use a credit card or other financing to pay for things that you could not pay cash for, you’re borrowing, and creating debt. Most people wouldn’t be as comfortable saying “debt is my safety net.” But if your financial strategy involves using credit to cover emergencies, that’s exactly what it means — debt is your safety net.

When we unpack this idea, several problems emerge quickly. The first one is the idea of using credit “just in case” of unforeseen emergencies. There’s an element of truth in this thinking — emergencies do come up in life. But to treat them with a “just in case” mentality amounts to nothing more than gambling: “I bet that no emergencies will happen to me this year, so I’m not going to plan for any. Instead, I’ll keep a credit card to use, just in case.”

In Las Vegas, the casino always has the built-in edge; you may win a hand or two, but if you keep playing, sooner or later you’re going to lose it all. The same is true in life — you may dodge emergencies for a while, but eventually the “house” is going to win. Emergencies will happen… it’s only a matter of when. Maybe you’ve heard of Murphy’s Law — “Whatever can go wrong will go wrong.” It’s a bit of a pessimistic attitude for life, but it illustrates an important principle. Bad stuff is going to happen from time to time, and it’s going to cost you money.

For wise financial planners, there’s no such thing as an “unforeseen” financial emergency. We may not know what the nature of the emergency is going to be, but we know that sooner or later, there will come a big expense that isn’t part of our regular budget. Wisdom says that instead of borrowing our way through these situations when they come up, we should plan for them, and build up some emergency savings (much more on this later).

Back to the myth: If you say “credit is my safety net,” you’re locking yourself in to using debt to float you through these emergencies that will inevitably arise. It’s a virtual guarantee that you’re going to get into debt — even though you have the best of intentions, and aren’t borrowing to pay for a lavish lifestyle, you’re leaving yourself exposed and defenseless against emergencies. That’s a sure recipe for getting into debt. Remember, the house always wins.

And to drive the final stake into this myth, consider this: Taking on debt always adds risk to life. No one can reposes your car if you own it free and clear, and you will never go bankrupt if you don’t owe anyone any money. The best safety net is a big emergency fund and good insurance policies; if you count on credit to save you in case of a small financial disaster, you’re actually increasing the chances that you’ll get into a big financial disaster later on.

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Comments

  1. Canadian Performer's Money says:

    Staying out of debt is one of the smartest things people can do as we head into an uncertain 2012.

    It should be illegal for those guys who hang out on college campuses and give kids their first credit card.

Trackbacks

  1. [...] us feel like we’re doing something good. After all, everyone borrows, right, to get through rough patches? And if everyone does it, it must be a good idea. Millions of Americans can’t be [...]

  2. [...] come back at you with a bunch of myths and excuses: Debt increases buying power; debt is a safety net; everyone has a little bit of debt. They’ll say that some debt is good debt, or that carrying [...]

  3. [...] debt in America. You may have signed up for your first credit card in college, either as an “emergency” backup plan or as an attempt to build a credit score. Because they were convenient, you [...]

  4. [...] not prepared with emergency savings, we end up dangerously exposed to bad circumstances, forced to take on debt or neglect life’s necessities in order to pay an unforeseen [...]

  5. [...] strategy might seem to work — if you borrow enough money, you can clean up any mess. But debt makes a crummy safety net. It costs us money to pay interest on the debt, and carrying debt adds risk to our financial [...]

  6. [...] Save too little and you leave yourself under-prepared when emergencies strike. That can leave you exposed to debt and other dangers. But if you save too much, you’re shorting yourself in the long-run, [...]

  7. [...] A lot of people first get introduced to debt as a “just in case” way to backstop their checking or savings account, and that has given rise to the myth that credit is a safety net. An increasingly large number of people rely on credit cards or other debt to help them deal with emergencies or unexpected expenses. The problem is that in the long run, debt actually increases the risk in your financial life. Whenever you borrow money, you add a liability to your life. If you have debt and then encounter a job loss or other emergency, you may find yourself unable to make your debt payments and be forced into bankruptcy. Credit is no safety net — it adds risk to your life. Learn more here. [...]

  8. [...] because they think that borrowed money will get them through a crisis. But it’s all a myth: Credit is no safety net. In fact, borrowing money compounds financial [...]

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