Can I Use My HELOC as an Emergency Fund?

Can I Use My HELOC as an Emergency Fund?

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In the wake of COVID-19, many nations have dipped into a widening recession. Given global economic interconnectivity, things are likely to worsen before they improve, as rising unemployment claims indicate. In May this year, Canada entered its own recession. Our neighbour to the south attempted to alleviate its financial crisis with record-breaking stimulus packages, but even they have ceased for the time being—and not everyone in need of relief has benefited. In an environment of economic uncertainty, where can ordinary citizens draw much-needed funds? If you find yourself with a depleted savings account and mounting bills, should you use your HELOC as an emergency measure.

How To Set Up An Emergency Fund Quickly & Easily

We've got everything you need to know to get your emergency fund started. Just how much will you need? Where should you keep it? Read on to find out!

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What Is a HELOC?

The acronym itself, HELOC, means Home Equity Line of Credit. In short, a HELOC amounts to issuing a secondary mortgage on your house. Just as you would borrow money in a pawn shop by pawning jewellery, a HELOC allows you to borrow money against the value of your home.

Of course, you’ll need to proceed with caution if you’re considering using the equity in your home for a financial emergency. Indeed, lenders can reduce or cancel a HELOC in some circumstances and failing to make HELOC payments can lead to foreclosure. With such high stakes, where you have to pay back both the money you borrowed and the interest rate, against losing your home, using your HELOC as an emergency fund should not be taken lightly!

Differences between an emergency fund and a HELOC

When we talk about emergency funds, we always mean funds on your savings or retirement account. Depending on which kind of account you have set up, as is the case with time-locked accounts, you could receive a penalty for withdrawing money.

However, even with such setups, the risk for your future financial security is relatively small compared with a HELOC. After all, you would be withdrawing your own money for an emergency, even with a minor penalty incurred. With a HELOC, you would effectively bet on your ability to secure future income against losing your home.

How to Use a HELOC as an Emergency Fund

First, you have to find a bank that offers HELOCs. Even those banks that have offered them in the past may have stopped accepting HELOC applications, as happened with Chase and Wells Fargo banks in May.

Provided your credit score is above 650, the bank will consider issuing a line of credit against the value of your home. These funds come with a withdrawal period between 5 and 10 years, with an APR (annual percentage rate) usually under 7%.

When your approved home equity line enters a repayment period, you will no longer be allowed to withdraw additional funds. Instead, you would have to start paying off the principal with the monthly interest rate. The repayment period usually lasts between 10 to 25 years.

The Pros and Cons of Using a HELOC as an Emergency Fund

For people with skills that are always in demand on the work marketplace, using a secondary mortgage as an emergency fund may seem like an easy choice to make. Others should take heed to explore less severe options first.

Pro: Quick Access to Large Sum of Money

If you are in dire need of cash due to a family emergency, or an investment opportunity that is hard to miss, there are few better options than a HELOC. Moreover, the HELOC interest rate almost always comes in lower compared with other lines of credit. Additionally, depending on what you use HELOC funds for, its interest rate may be tax-deductible up to $100,000.

Con: Fees and Closing Costs

Aside from origination and annual fees, a HELOC comes with an interest rate of 3–9%. Be sure to fully have a handle on your personal finance, and understand all the underlying costs. Be aware that, as a secondary mortgage, HELOCs will have higher interest rates than primary mortgages.

Pro: May Never Need to Access It

With a generous withdrawal period between 5 and 10 years, you will have peace of mind, without ever having to withdraw the money and start paying interest. However, you will have to pay the annual fee regardless, for the funds to be available. This annual fee is usually between $50 and $100.

Con: Variable Interest Rates and Possibility of HELOC Reduction or Cancellation

The bank may decide to change the terms of their credit line. This doesn’t often happen, but that’s not the case during big economic upheavals. If the bank decides to reduce your approved HELOC, you could find yourself in a position where the credit limit would match your balance. Of course, this would defeat the original purpose of a HELOC as an emergency fund, making it a bad idea in hindsight.

Additionally, banks tend to issue HELOCs with a variable interest rate. In theory, they could go from 4% to 8% monthly interest rate, which would make it much harder to pay off alongside your living expenses.

Conclusion

If you are confident in your ability to secure a steady income source, and you need a large sum of money quickly against the value of your real estate, a HELOC may be a good idea. This is especially true if you would use that money for a tax-deductible purpose. However, if you doubt your ability to secure monthly repayments at their maximum possible high interest, it might be best to look for a short-term emergency fund with milder stakes.

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