Is using a HELOC for an emergency fund a good idea?
Using a HELOC as an emergency fund can provide peace of mind, knowing you have extra cash available in case of a medical emergency or other urgent need such as buying a new car or making emergency home repairs in the case of a natural disaster.
However, there are drawbacks to using a HELOC to pay for emergency expenses, including the variable interest rate, using your home as collateral, and fees associated with opening a HELOC and not using it.
Read on to learn more about using a HELOC as an emergency fund.
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What are HELOCs and how do they work?
A Home Equity Line of Credit (HELOC) is a type of “revolving” credit that is provided by a lender which has a credit limit, a variable interest rate, and which is secured by the equity in your home. Most HELOCs have a 10-year “draw period” during which money can be borrowed, followed by a repayment period.
There are HELOC pros and cons to consider. One of the advantages of a HELOC is that you can take out money as you need it, and you will only pay interest on the amount you use.
Can HELOCs be used to pay for emergencies?
Yes, the money you get with a HELOC can be used any way you choose. This includes using a HELOC as an emergency fund to pay for emergencies, such as bills resulting from medical bills or unexpected home repairs.
For example, there are tax advantages to
using a HELOC for home improvements. According to the
IRS, interest on home equity loans and lines of credit are deductible only if the borrowed funds are used to buy, build, or substantially improve the taxpayer’s home that secures the loan. The loan must be secured by the tax-payer’s main home or second home (qualified residence) and meet other requirements.
What else can HELOCs be used for?
HELOCs are very popular with homeowners because they have a lower interest rate than credit cards. And you can use the money any way you’d like! Some of the
best ways to use a HELOC include:
- Making home improvements
- Covering large medical bills and paying for medical procedures
- Paying college tuition
- Paying off high-interest credit card debt
- Starting a business
How to use a HELOC in an emergency
Using a HELOC as an emergency fund is easy if you've already been approved for the loan. If you have an open HELOC you can simply write a check from your account or use the debit card linked to the account.
The time it takes to
get approved for a HELOC can be two to six weeks. In an emergency, if you do not already have a HELOC, you may be better off using your savings account or one of the alternatives discussed later in this article.
Advantages to using a HELOC in an emergency
HELOCs are easily accessible. Once you are approved and receive your funds, you'll be able to make payments using checks or a debit card for your HELOC account.
Interest-only payments during draw period. During the draw period most HELOCs charge interest-only, on the amount of the loan you use. After the draw period ends and the repayment period begins, you'll be required to start paying back any outstanding principal, as well as interest.
Lower interest compared to credit cards. HELOCs start with a low variable interest rate that typically stays in effect for a10 year draw period, during which you can draw from your line of credit. The interest rate on a HELOC may be lower than interest charged on credit card debt and personal loans.
Disadvantages to using a HELOC in an emergency
Variable interest rates. HELOCs typically start with a variable interest rate which may change to a higher variable rate after the promotion ends or may convert to a fixed rate.
As the rate goes up, some borrowers find it difficult to repay the loan at a higher rate. Failure to repay a HELOC means the lender could foreclose and take possession of your home.
Your home will be used as collateral. Because HELOCs are given based on the equity in the home, your home will be used as collateral. If you default on the loan, the lender can do a foreclosure and you could lose your home. Failure to make on-time loan payments will damage your credit score.
Risk of overspending. Having easy access to money makes it tempting to overborrow or spend the money on luxury purchases that aren’t necessary. Be sure to use your HELOC for the original intended purpose.
How long can I keep my HELOC open?
After your HELOC draw period ends your HELOC may have a 20-to-30-year repayment period, during which you will be required to repay the loan. Some lenders may require that the loan be closed after the loan is fully paid off and can no longer be used. Often, a homeowner will sell their home during this time and the loan is closed when the home is sold. There are different requirements
when you sell your home with a HELOC still open.
How do HELOC repayments work?
The specific terms for repaying your HELOC will be given to you when you are approved for the loan. All HELOCs have a “draw period” (typically 10-15 years) and a “repayment period” (typically up to 20 years). During the draw period, you can borrow as much of the funds as you need. Payments made during the draw period are calculated as “interest only,” meaning you aren’t repaying the entire loan or the principal amount. Some lenders will allow payments toward principal during the draw period, to help make it easier for people to manage their finances by avoiding a large “balloon” payment when the repayment period starts.
After the draw period ends, the HELOC repayment period begins. At this time, most HELOC interest rates will adjust to a fixed rate and monthly payments will include both principal and interest on the outstanding balance.
Alternatives to using a HELOC in an emergency
If you need cash fast and can't wait to be approved for a HELOC or prefer to not dip into your home equity, here are some alternatives to consider:
Use existing savings. Using your savings to pay for emergencies is usually the best place to start, after all, that's what a savings account is for. If your emergency will require more money than you have in your savings account, one of the following options may work for you.
Personal loan. Personal loans are offered by credit unions, banks, and online lenders. Each type of lender will have unique interest rates, loan terms, fees, and possibly a prepayment penalty. Be sure to shop around and get all the details before you accept the loan.
0% APR credit card. In an emergency, making payments with credit cards is fast and convenient. Many credit cards offer a promotional 0% APR (annual percentage rate) on balance transfers for a fixed period, usually 12 months. If you have large credit card balances, try applying for one of these cards and transfer your high balance to the 0% APR card, which will give you more time to pay off the debt interest-free. However, after the promotional rate expires, there will be a new higher rate applied to the outstanding balance.
Ask for help from family or friends. Borrowing money from a family member or friend can be a quick way to get the money you need. While borrowing from family or friends can be tempting, consider first that loans from family and friends have emotional attachments that could negatively impact your relationships.
401(k). A 401(k) is an employer-sponsored retirement savings plan. According to the IRS most retirement plan distributions are subject to income tax and may be subject to an additional 10% tax unless you're age 59½ or older. Penalties for early withdrawal of your money may be exempt under certain emergency medical situations.
Why Savvy Consumers Choose CU SoCal
For over 60 years CU SoCal has been providing financial services, including HELOCs, car loans, personal loans, mortgages, credit cards, and other banking products, to those who live, work, worship, or attend school in Orange County, Los Angeles County, Riverside County, and San Bernardino County.
Please give us a call today at 866.287.6225 today to schedule a no-obligation consultation with one of our HELOC experts.
Get Started on Your Home Equity Line of Credit Today!