I am unemployed and almost to the end of my emergency savings, which I've made last seven months, by the way, for both me and my 8-year-old son. I am applying for jobs like crazy (I made $80,000 a year before getting laid off), but some health problems got the better of me for the past three months. Anyway, excuses, excuses. Here's the thing: I know that you're not supposed to use your credit cards for living expenses, and I agree. But, in another month, they may be my only option if I haven't managed to get a good job. So, what do you think are OK things to charge? What is your advice for not getting too deep in the hole, and what's your advice for getting on top of my debt once I do finally get a job? As of now, I have no credit card debt, and I have a $35,000 limit across three cards. -- Janette
Credit cards are an easy solution to short-term cash flow problems, but as you rightly suspect, unless you proceed with caution, you could quickly get trapped in debt.
Here's the twofold nightmare scenario you will want to avoid: First, it's all too easy to run up a credit card balance with huge monthly interest charges, which will only add to your financial hardship. Second, as interest charges pile on and the credit card bills escalate, many people end up with credit card bills so high they have difficulty making the monthly payments.
Once you fall behind on payments, your credit score tanks, and all lines of credit quickly dry up. Even that comforting $35,000 credit limit you have across your three credit cards could vanish overnight. If card issuers get wind that you are in financial trouble (if you miss payments, for example, or they see your credit score take a dive), they could slash your credit limits, thereby effectively damaging your credit score by decreasing your credit utilization ratio. If you pay late, your bank may also hike your APR, causing you to amass debt more quickly.
In short, while it's not out of the question to use credit cards for emergency expenses, you have to plan ahead very carefully. Here are some important steps to take before you turn to credit cards:
- Cut your expenses. You have likely already done this, otherwise your savings wouldn't have lasted as long as they have. However, when you're used to an income of $80,000 a year, reducing living expenses sufficiently to suit your current income will not happen instantaneously. Don't keep holding out for that new job. You must plan for all contingencies so that you don't end up with severe financial hardship, if that job doesn't materialize any time soon. If you haven't done so already, consider these painful (but effective ways) to cut your spending.
- Downsize. Cutting your expenses is one thing, but there's only so much you can cut without downsizing your lifestyle. Take a moment to do a reality check: If you're still unemployed a year from now, would you be able to live where you're living and drive the car you're driving? Could you sell your car? Could you and your child move from a house to an apartment? These are hard questions to answer, but unfortunately, you don't have a choice — you have to adjust your lifestyle to whatever your current income is (presuming you are getting unemployment benefits) and not what you hope it will be once you land a job.
- Look into cheaper loan options. Interest rates on credit cards can climb to 20 percent or higher. You might be able to get a better deal. If you own a home, look into a home equity line of credit or cash-out refinancing. Or, if you can get a lower interest rate, consider taking out a personal loan from a bank. Last but not least, if credit cards still are the only option, reach for the one in your wallet with the lowest interest rate.
- Turn to credit before exhausting emergency savings. Whichever type of loan you end up taking out, make sure you have the money to pay the monthly loan payments. So the time to turn to a loan (or credit card, if nothing else is available to you) is before your emergency savings are exhausted. Calculate what you can pay in monthly payments on the loan for the next two or three years using your current emergency savings or unemployment income. That will determine the maximum amount that you can borrow without jeopardizing your financial stability.
You are in a tricky financial situation, and it's important to avoid making decisions that would create lasting financial hardship for you and your son. The more you plan ahead, the more likely you are to sail through this challenging time without long-term repercussions.
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