Using a HELOC as an emergency fund

Quick insights

• HELOCs allow you to leverage your home’s value for any purpose, including emergency expenses.
• The interest rates available with HELOCs and flexible access to money may make this form of credit appealing for emergency use cases.
• The risks of using a HELOC for emergencies are significant, including the potential of losing your home to foreclosure if you default on the loan.

A home equity line of credit (HELOC) is a financial tool that allows homeowners to tap into the value of property they own for various costs. Some people also choose to use this line of credit as an emergency fund when unexpected expenses or bills arise. In this article, we’ll dive into how HELOCs work, along with the process, pros and cons of relying on this type of credit for emergencies.

A quick refresher on how HELOCs work

A HELOC works a bit like a credit card: it’s a revolving line of credit that homeowners can draw from for expenses and repay. Unlike credit cards, a HELOC is a secured form of credit that uses your home’s equity as collateral. During the approval process, a homeowner’s creditworthiness and the available equity in the home will be assessed, and a limit will be established.

A HELOC is considered active and usable during the “draw period,” which typically lasts 3-10 years. During the draw period, you can withdraw money and typically repay only the interest, if you choose. Paying options during this period vary by lender and specific terms of the HELOC. When the draw period concludes, the borrower must then pay the remaining balance (both principal and interest) over the “repayment period,” which could extend up to 20 years.

Evaluating HELOCs and emergency funds

In general, it’s cautious to have an emergency fund at your disposal for unexpected expenses. This often takes the form of a savings account, set aside with 3-6 months of expenses. However, there are typically no restrictions on what a HELOC can be used for. If you’re considering opening a HELOC to use some or all of it for emergencies, here are some potential pros and cons.

Pros of using a HELOC as an emergency fund

• Quick access to money: Most HELOC accounts make money easy to access, sometimes via direct transfer to your bank account or with an associated card.
• High credit limit: HELOCs allow approved homeowners to borrow a certain percentage of their property’s appraised value, minus the outstanding mortgage balance (if any). Depending on the value of the home, the amount owed and other details of the applications, this could be a significant amount.
• Lower interest rates: Because HELOCs are secured loans, they typically have lower interest rates than credit cards or other unsecured lending options.
• Flexibility: You can borrow as much (or as little) as you need, up to your credit limit, repay and re-borrow. During the draw period, you can also choose to make interest-only payments, depending on your lender. This could lessen the financial burden of the loan until the repayment period.

Cons of using a HELOC as an emergency fund

• Risk of losing your home: Because a HELOC is a secured form of credit that uses the associated property as collateral, failure to repay during the repayment period may put your home ownership in jeopardy. HELOC creation places a voluntary lien on the property, which grants the lender the right to sell your home following a default on the loan.
• Variable interest rates: HELOCs generally adhere to a variable interest rate structure, meaning that the interest rate you owe may change depending on the prime rate, which is influenced by the Federal funds rate and market conditions.
• High limits and interest accumulation: While HELOC accounts may provide a higher credit limit and lower interest rates than other lending options, these factors still need to be monitored. Without careful use, it’s possible for debt to accumulate and become problematic for the borrower.

Other common emergency fund strategies

When emergencies come up and money is needed fast, other possible strategies to manage the expense include home equity loans, cash in savings accounts, personal loans, credit cards or borrowing from a family member or another close connection.

Cash-backed savings accounts

If you're a homeowner with an otherwise tight budget, it may be challenging to set money aside for expenses, especially those that can’t be fully anticipated. However, setting aside money in a savings account could offer the additional benefit of interest earned, as opposed to interest owed.

Home equity loans

Like HELOCs, home equity loans (sometimes referred to as a “second mortgage”) are secured by the homeowner’s property, which can mean lower interest rates when compared to unsecured personal loans. Unlike HELOCs, these loans are paid out in one sum and repaid according to a stricter schedule.

Personal loans

Personal loans can be either secured (such as by a car or savings account) or unsecured, which can result in higher interest rates. Like a home equity loan, personal loans are typically paid out as a single lump-sum and repaid on a predetermined schedule. Chase does not offer personal loans.

Credit cards for emergency expenses

Credit cards can offer the same (or better) accessibility of an open HELOC account. However, the interest rates of credit cards can make them expensive financial tools. Additionally, a credit card account is also unlikely to offer the same maximum as a HELOC.

Borrowing from a personal connection

Sometimes a close friend will be willing to cover shortages on rainy days. Depending on the terms of your agreement with them, it could be your most cost-effective option. However, relying on a friend or family member’s kindness comes with personal risks, including the potential to damage your relationship.

Mitigating the risks of a HELOC for emergency purposes

Knowing the risks of using a HELOC for emergency purposes, you can take certain precautions to prevent or lessen their impact. For example, exercising discretion and using a HELOC only for genuine emergencies can avoid the accumulation of unnecessary debt. Creating a repayment plan for yourself can also help you prioritize faster repayment and limit interest charges. Finally, staying informed on market conditions (including your home’s value) can help you use a HELOC strategically.

In summary

So, should you get a HELOC, just in case? While this option may be worth exploring, the answer is personal and depends on many factors. For guidance as you weigh your options, it can be helpful to meet with an experienced financial advisor who can make personalized recommendations.