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.