HELOCs Double As Emergency Funds
Break glass in case of emergency. Most people are familiar with this method for extracting a fire extinguisher, axe, or other lifesaving tool from behind a layer of safety glass in the hallway of a building. Its unfortunate that other emergency tools, such as funds to deal with unexpected home repairs, medical bills, or a job loss, cant be so easily accessed. Or can they? A home equity line of credit (HELOC) could be an emergency fun when a homeowner is experiencing a financial crisis.
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The Workings Of A HELOC
Home equity is the difference between the appraised market value of your home and the balance owed on your mortgage. If the difference, or equity, is large enough, you can use a HELOC to access it in case of emergencies such as a leaky roof, busted water heater, flooded basement, or appendectomy
In many ways, its like a credit card, only with a much lower interest rate
. And you pay interest only when theres an outstanding balance which means you were using the money. If you dont have a balance, you dont pay anything at all. Unlike a credit card, however, if you use the line and fail to make the payments, the bank could foreclose on your home.
Creating An Emergency Fund
Financial planners traditionally advise keeping three to six months worth of living expenses in liquid assets, such as savings accounts, short-term bonds, and CDs
. The harsh reality is, however, that it can be difficult for the average homeowner to save that much cold hard cash for emergencies. With layoffs and reduced hours, rising gas prices, and higher grocery costs, family finances are already stretched thin. If youre able to save a portion of your earnings for an emergency fund, thats great. But if you cant, and you have equity in your home, you can always take out a HELOC. Even if you have the money put away, its not a bad idea to have a line of credit through your home just in case the unthinkable happens.
Its best to apply for a HELOC before you fall on hard times.
That way, the funds will be available if and when you need them. If you wait until youve lost your job or have fallen behind on credit card payments, lenders will likely turn you down for the loan and youll be back to rainy-day savings alone. Fortunately, closing costs on HELOCs are generally low. Some banks will cover the closing costs completely, so it pays to shop around for the best offer.
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Drawbacks Of HELOCs
The interest rate on a HELOC is variable, so your rate could go up in a rising interest environment.
You should also review your loan documents carefully before signing on the dotted line. You dont want a HELOC with a prepayment penalty. You may also encounter loans with cut-off points at which youll no longer be able to draw funds regardless of remaining equity.
Its often said that the only certain things in life are death and taxes. But emergencies, whether large or small, are also certain to strike at some point. With a home equity line of credit, you can break the metaphorical glass before an emergency shatters your life.