Can I use a HELOC as an emergency fund?

October 17, 2016

One of the biggest principals in personal finance is the emergency fund. It’s supposed to protect people when life happens, whether that’s a surprise trip to the emergency room or a speeding ticket.

Things come up, and when they do, most Americans put it on a credit card or take out a short-term loan. But if you do want to have an emergency fund for all those “what-if” situations, what should you do? What’s the best way to save for one? And if you’re a homeowner, can you use your home equity or a HELOC as a stand-in for cash in your savings account?

Read below to see what the experts say about using your HELOC instead of a pile of cash.

What is a HELOC?

A HELOC stands for home equity line of credit and is a type of loan where the collateral is the equity in your home. For example, if you have a $150,000 mortgage and have paid $50,000 of the principal on the loan, you have $50,000 worth of equity in your house. A HELOC will let you borrow money by tapping that equity.

One of the tax benefits of HELOCs is that you can usually deduct the interest you pay on the line of credit. However, a downside to using a HELOC is that the line of credit is directly tied to your home, so you risk losing your house is you fail to make payments or default on the HELOC.

Should a HELOC be an emergency fund?

Most experts recommend saving between three to six months of expenses for an emergency fund that you can use for unexpected hospital bills, surviving when you lose your job and paying to fly to a funeral.

Saving for that amount, on top of stashing money for retirement or your kid’s college fund, can seem unreasonable and difficult for many Americans. That’s when they might turn to a HELOC as a backup plan.

Unlike loans, a line of credit can be taken away at any time, usually if the value of your home collapses or if the bank thinks you’re no longer a qualified borrower. This can happen relatively quickly and leave you frazzled, especially if you’re dealing with another financial crisis.

Which One is Better?

Even if you have access to more money through a HELOC than you’d be able to save in a checking account, it’s still safer to keep your emergency fund as cash. The instability of HELOCs make them a poor choice for emergency funds, and they often have higher interest rates than your regular mortgage.

If you have a true emergency (losing your job, paying for a funeral, having to move for a new job), you may have more expenses than usual.

Opening a HELOC when you have an emergency means you’re taking on debt while dealing with a catastrophe. Even though the interest is tax-deductible, you will still owe part of that interest to the bank.

However, some people maintain that by putting your efforts into paying off your mortgage instead of saving for an emergency fund, you could reduce your principal, increase your equity and save money on interest.

CFP Tom Diem of Diem Wealth Management said getting the best deal on your HELOC includes having a high credit score and a solid income-to-debt-payment ratio.

Deciding between a HELOC and a cash emergency fund depends on your job stability, your home appraisal, and how much risk you can tolerate. If you feel comfortable using a HELOC, go for it. But if you want a solid emergency fund, cash is king.

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