Using a HELOC as an Emergency Fund: Pros, Cons, and Best Practices

If you own a home, you may want to put your equity to work for you. By using products like HELOCs, you can create a cash source from what’s likely your most valuable asset. However, using a HELOC as an emergency fund, especially if it’s your only source of emergency funding, can be risky. Below, we’ll break down what a HELOC is and the benefits and drawbacks of taking a HELOC for emergency fund approach. We’ll also offer some alternative options for homeowners.

How Using a HELOC as an Emergency Fund Works

A HELOC, or home equity line of credit is a flexible, revolving line of credit secured by your home. Like a credit card, you can borrow what you need, repay, and borrow again up to a specific limit, often up to 85% of your home’s value, minus whatever you still owe on your home loan.

Using a HELOC as an emergency fund, then, involves opening one “just in case,” so you can borrow against the value of your house in the event that you encounter an unexpected financial circumstance or emergency. It’s basically like having a very high-limit credit card on reserve, just for emergencies. Plenty of people opt to do this, and it can be a cheaper form of debt than credit cards or personal loans.

However, there are also downsides to this approach, including the fact that HELOCs can be expensive, even if you don’t actually tap into your borrowing power. Opening a HELOC often comes with closing costs of up to 5% of the credit line, as well as maintenance fees that could cost up to $100 per year. Below, we’ll get into more of the pros and cons of using a HELOC as an emergency fund.

Pros of Using a HELOC as an Emergency Fund

Before we dive into the potential drawbacks, let’s take a look at the reasons a HELOC might actually work well as an emergency fund.

•  HELOCs often have a large limit. With funds available up to 85% of your home’s value, minus your mortgage balance, you may be able to cover a wide range of emergencies.

•  HELOCs also have lower interest rates than many credit cards or personal loans, so any debt you do acquire may cost less over time.

•  Quickly available. You can often have access to a HELOC within just a few weeks of applying, which is much quicker than saving up cash for a traditional emergency fund.

•  Flexibility. Unlike taking out a lump-sum personal loan, with a HELOC, you can borrow — and pay back — only what you really need.

Cons and Risks of Using a HELOC as an Emergency Fund

On the other end of the spectrum, though, there are drawbacks and risks associated with the HELOC as emergency fund plan. For instance:

•  You’re limited by the draw period. HELOCs are separated into a draw period, during which you can borrow funds, and a repayment period, in which you repay them. In general, the draw period is only up to a decade, so your access to funds won’t last forever.

•  Fees may apply. As mentioned above, you could end up paying one-time closing costs of up to 5% of the total credit line — which, at 85% of your home’s value, could add up to a substantial sum. There may also be ongoing maintenance costs associated with the HELOC, and even a small amount each year adds up over time.

•  If you don’t use it, you may lose it. As with an inactive credit card, your account may be closed by some lenders if you don’t borrow for a long period of time, such as 18 or 24 months. Lenders may also have the ability to freeze or reduce your credit line if there’s a major economic downturn, as happened in the housing market crash of 2008.

•  You may find yourself dipping into your HELOC too often. You can use a HELOC for practically any expense, and after opening one, some homeowners may find themselves dipping into the credit line for other expenses. This is fine as long as you can make your payments. But people who have difficulty managing their use of credit could find this large credit line risky.

•  Repayments can be unpredictable. Many HELOCs are offered at a variable interest rate, which makes the repayments you’ll eventually make somewhat unpredictable.

•  Your home is collateral. That means that if you can’t make your HELOC payments, it’s possible that your home could eventually go into foreclosure, since it’s the asset that secures the loan.

Who Is Best Suited to Use a HELOC as an Emergency Fund?

Because of the risks and drawbacks associated with HELOCs, it’s generally advisable to have another source of emergency funding, such as cash savings in a savings account, along with a HELOC if you do decide to open one.

Those for whom using a HELOC as an emergency fund is less risky include people with:

•  Good credit history

•  Reliable cash flow

•  A steady source of income

•  Little existing debt

•  Substantial equity in their home

Generally speaking, having a favorable financial profile means you’re less likely to find yourself behind on repaying your HELOC, which can be a risky situation for a homeowner.

How To Find the Right HELOC for an Emergency Fund

Shopping around can help you save substantially on the HELOC you open as an emergency fund. For example, if you can find a HELOC with low fees or no closing costs, you may save thousands of dollars compared to a more expensive HELOC.

It’s also usually a good idea to look closely at the HELOC’s terms, including any clauses about the lender closing inactive accounts if you’re not planning on any immediate borrowing. Some lenders require an initial draw, which usually isn’t favorable for borrowers hoping to just have the borrowing potential on reserve. And, of course, you’ll ideally want a HELOC with the longest draw period possible: 10 years, rather than the five that are offered by some lenders.

Additionally, you may want to shop around for a HELOC for emergency fund use before you actually need one. Because it can take up to six weeks to fulfill a HELOC application, they aren’t a good source of emergency funding if you need it immediately.

HELOC Emergency Fund Alternatives

While using HELOCs as emergency funds may work for some borrowers, there are important alternatives to HELOCs to be aware of.

•  Cash savings. This is the preferred method for starting an emergency fund. When you build up a cash cushion, ideally in a high-yield savings account (but not an investment account), you have access to a way to pay for emergency costs without going into debt.

•  Home equity loans. If you’re already considering borrowing against your home’s value, a home equity loan can be an alternative source of emergency funding. A home equity loan allows you to take out a lump sum — often, again, up to 85% of your home’s value — which can be used to repay medical bills or another large and unexpected emergency cost.

•  Cash-out refinancing is another option for homeowners. It involves refinancing your home with a larger mortgage loan, taking out the difference as cash. However, refinancing is only a good idea if you can obtain a mortgage interest rate that’s lower than the one you currently have.

•  401(k) loans are another way to access emergency funds in a pinch, and because you’re borrowing from yourself, there’s no credit check or qualification process. However, taking money out of your retirement account can severely impact your gains over time and put your retirement savings at risk.

•  Credit cards and personal loans can also be used to get money at the last minute, but both tend to carry higher interest rates than loans and lines of credit secured by an asset, often making them an expensive choice. Additionally, it can be easy to fall into a debt spiral with credit cards, which can make an existing financial emergency even worse.

Recommended: Where to Keep Your Emergency Fund

The Takeaway

A home equity line of credit, or HELOC, can be used as an emergency fund — but it’s important to understand that it is a form of debt, and one that can put your home at risk if you find yourself unable to repay it.

SoFi now offers flexible HELOC options to turn your home equity into cash. Access up to 85% of your home equity, or $350,000, to finance home improvements or consolidate debt. Competitive interest rates and repayment terms up to 20 years could result in lower monthly payments versus other loans. And the online application process is quick and convenient.

Unlock your home’s value with a home equity line of credit from SoFi.

FAQ

Can a lender freeze your HELOC during a financial crisis?

If market conditions mean your home declines substantially in value — as happened in the 2008 housing market crisis — a HELOC lender could freeze your account.

Does an unused HELOC cost you anything?

Opening but not using a HELOC can sometimes be costly. Many HELOCs come with ongoing maintenance fees, which can add up yearly, and you may still need to cover closing costs to take the HELOC out in the first place, even if you never borrow against it. Costs vary according to the lender, so it’s important to explore a HELOC’s rules before signing on.

Is a HELOC better than a high-yield savings account for emergencies?

Having a high-yield savings account you can tap as an emergency fund is generally better than relying on a HELOC. A high-yield savings account allows you to cover emergency situations without going into debt, which is almost always preferable.

How large should a HELOC emergency fund be?

A HELOC allows you to have a revolving line of credit of up to 85% of your home’s value. For most homeowners, this is a large enough number to cover a wide range of potential emergencies.

What happens to your HELOC if your home value drops?

If your home drops in value, a HELOC lender may reduce your credit limit — or, in some cases, freeze your account. In extreme scenarios, a HELOC lender might close your account and demand immediate repayment. This could happen in adverse market circumstances, but it could also occur if you regularly miss payments.

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Photo credit: iStock/ ToucanStudios

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