Can I Use a HELOC as My Emergency Fund?

How a HELOC Works

A home equity line of credit is a type of second mortgage that you can use to access some of the equity you have in your home. Unlike a home equity loan, which provides a lump-sum payment in exchange for fixed monthly payments, a HELOC acts similarly to a credit card.

You'll get a revolving line of credit, which you can borrow against, pay off and repeat. You'll only pay interest on the amount you've borrowed.

The amount of your credit line will depend on how much equity you have in your home and the lender's loan-to-value (LTV) ratio limits. Some lenders may not allow you to exceed a combined LTV of 80% between your primary mortgage loan and your HELOC, while others may go as high as 100%.

In most cases, HELOCs have variable interest rates, which can fluctuate with market rates. However, some may allow you to convert some or all of your balance to a fixed interest rate, which you'll then make fixed monthly payments on until it's paid in full.

HELOCs typically charge low interest rates, though, at least compared with other variable-rate options like credit cards. This is because the loan is secured by your home. That said, when you close on a HELOC, you may need to pay certain closing costs. Some lenders may also charge annual fees.

Common reasons people take out HELOCs include:

• Making home renovations
• Paying off high-interest debt
• Making a down payment on an investment property
• Paying medical bills
• Paying for tuition and other educational expenses
• Starting a business

Is Using a HELOC as an Emergency Fund a Good Idea?

You can use a HELOC as a way to cover emergency expenses as they arise. However, there are some potential drawbacks that may cause you to think twice. Here are the pros and cons to consider.

Pros

• Easy access to cash: Once you've closed on the loan, accessing your line of credit can be as simple as writing a check, requesting a bank transfer or using a debit card tied to the account.
• Funds are available when you need them: It can take several years to build a meaningful emergency fund, and dealing with various emergency expenses during that time can make you feel like you're taking two steps forward and one step back. Depending on how much equity you have in your home and lender limits, you may qualify for a big enough credit line to meet all of your needs, even for long-term emergency expenses.
• Cheaper than a credit card: Many people rely on credit cards when they can't afford to get by on their income alone—but credit cards charge an average interest rate of about 16%, according to November 2021 data from the Federal Reserve. In contrast, many HELOC lenders charge interest rates in the single digits.

Cons

• Variable interest rates: Because HELOC interest rates can increase along with market rates, using a HELOC could become less affordable over time, which can put more strain on your budget during times of hardship.
• You may lose your home: If your financial situation makes it difficult to keep up with your HELOC payments, the lender could potentially foreclose on your home, making an already difficult situation much worse.
• Risk of overspending: Having access to a relatively inexpensive line of credit could tempt you to spend money that you don't have, even during times when you're not struggling financially. If you take out a HELOC as an emergency fund, then end up using it for something else, your options may be limited when an actual emergency arises.

Alternative Ways to Get Money in an Emergency

If you experience a financial emergency or you want to be prepared but don't want to use a HELOC, here are some other potential ways you can get access to cash when something unexpected happens:

• Ask a family member or friend for help.
• Apply for a 0% intro APR credit card.
• Use existing savings.
• Sell personal belongings you no longer need.
• Pick up odd jobs.
• Seek out community assistance organizations.

As you consider potential options, keep in mind that working on building your emergency fund is ultimately the best thing you can do to prepare yourself for the unexpected.

How to Build an Emergency Fund

Financial experts recommend keeping between three and six months' worth of expenses in an emergency fund. That's an ambitious goal that can take a long time to achieve, but any amount you can save will help. Here are some tips to help you get started:

• Make a budget to see where your money is going and make adjustments to your spending to create space for emergency savings.
• Establish your savings goal and come up with a monthly plan to meet it.
• Set up automatic transfers from your checking account to your savings account every month.
• Save some or all of your unexpected income and windfalls, such as tax returns and employer bonuses.
• Look for opportunities to make more money that you can put directly into your savings.
• Use some of your extra cash to pay down high-interest debts like credit card balances, so you'll have more cash flow to save in the future.

Again, building an emergency fund takes time, but the sooner you start, the faster you'll accomplish your goal.

How Your Credit Can Help in Emergencies

A good credit score can not only help you qualify for good interest rates on a HELOC, but it's also crucial to getting favorable interest rates on your loans and credit cards. The lower your rates, the more money you'll have to build your emergency fund and get access to financing when you need it.

Monitor your credit regularly to get an idea of your credit health, and take steps when necessary to address issues that could damage your credit. If you've made missteps in the past or you're relatively new to credit, it can take some time to build and maintain good credit. But in the end, it can provide you with ample opportunities in an emergency to get the money you need to get back on your feet.