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Your HELOC is NOT Your Emergency Fund

Let me say that again: Your home equity line of credit (HELOC) is NOT your emergency fund.

Even in the good times, but particularly when the times are tough, you want an emergency fund that is cold hard cash. Even if the bank where you’re keeping the cash gets taken over, FDIC insurance will cover $100k per depositor (as long as the bank was FDIC insured).

An emergency fund that’s credit of any kind isn’t really an emergency fund at all. It’s an emergency possibility, but not something you can count on. A credit card’s limit can be lowered at any time for any reason. A HELOC can be lowered or frozen.

For example, you could lose your HELOC if:

Your house’s price goes down and your equity decreases.

You lose your job (and therefore need the emergency fund) and are no longer a good credit risk.

You do something which lowers your credit score and your

Even if your house is in an area where prices aren’t going down, you’ve got great credit, etc, your bank may still freeze your HELOC (fortunately, Nina’s wasn’t her emergency fund). That’s in the best of circumstances. Their reasons may not even have anything to do with you, they may be cutting back on their HELOCs everywhere because the bank is in trouble.

You may counter, “But the HELOC is essentially my money, since I put that money into equity!”

Sorry, it’s not. In your original mortgage, your bank bought the house and decided to sell it to you in installments. When it gives you a HELOC, the bank essentially buys back part of your house that it’s already sold you and sells it to you again.

In good times, banks like this because they get to sell you the same thing twice and make interest on it both times. But it’s completely up to the bank whether or not they want to buy and resell your house. You can’t make them buy part back the same way you can’t make anyone else buy your house.

Don’t count on being able to use your home equity, ever. If you have a HELOC available and choose to use it in an emergency, that’s your decision. You just can’t plan on it being there when you need it most. In fact, the circumstances in which you’ll need it most may be the exact circumstances in which you lose it.

If you don’t have a cash emergency fund already, start one today. It doesn’t have to begin with some dramatic step. If you don’t have $1000 or the money to cover 3 months living expenses, start snowflaking it today. Because credit is just potential money.

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Emily September 29, 2008 at 11:22 am

I totally totally agree. In most instances, I don’t really see a good reason to have a HELOC. I see people use them just for everyday living expenses and over the top gadgets and such. I just don’t get it. The way that we’re shown all these new and creative ways to stretch ourselves further and make ourselves believe that we can afford things that we cannot is staggering. But America has fallen for it.

FFB September 29, 2008 at 11:51 am

Seems to me that a HELOC is an excuse to get some money and go spend more. It’s another item that has helped lead us into this credit crisis. I’m sure there are times when they are truly useful and needed but I have to say if you don’t have the money don’t go thinking you can spend!!

Budgets are Sexy. September 29, 2008 at 11:52 am

hey now, where were you 10 months ago when my HELOC froze 😉 haha…luckily, ours is used as a 2nd mortgage and thus was already maxed out, but still….had i not gone all frugal this year i very well could have gotten stuck w/out an emergency fund!

good post my dear.

Julie N September 29, 2008 at 1:35 pm

One of my family members recently had their HELOC frozen because their home value had dropped drastically. This is an awesome post and I hope others take heed. Having a cold hard cash emergency fund is the only way to go…unfortunately, I’m speaking from experience here.

My Daily Dollars September 29, 2008 at 4:57 pm

Great post! Our HELOC was reduced recently. I totally agree; the best emergency fund is cold, hard cash.

Dad September 29, 2008 at 6:12 pm

Excellent post! People say that your home equity is your money. That is basically true is one case: if you can sell your house for what you think it is worth. Then in a hard cash sense the equity is yours. All kinds of reasons may interfere with that. You mentioned the drop in the housing market. Another is that you may not have a better alternative for living arrangements. I see one real use for Home Equity Line of Credit and that is for home improvements (and I don’t mean a super big wide screen TV or even a swimming pool). True home improvements increase the value of the house. Contrary to many peoples notions, swimming pools often decrease the value of a house (I would buy one only if I had to, having been caught in that cash sink before).

HELOC is simply the banks way of luring you into the buy now and pay later (and pay and pay and pay).

I just read an analysis today that said that consumer credit was introduced into our culture in the 1920s in the great boom that turned into a historic bust in 1929. We are looking at a repeat of that same thing. It is only one factor in today’s crisis but it is a factor.

FruGal October 1, 2008 at 5:52 am

Couldn’t agree more. It makes me cringe when I hear of people borrowing against the equity in their homes for any reason really – having equity in your home is security against falling property prices and rising interest rates.

Scott @ The Passive Dad October 1, 2008 at 4:19 pm

I agree. Heloc are being cut by banks and several friends have received notices that lines of credit have been decreased by 50% or more. Scary to think of an HELOC as a savings account. Maybe an account of last resort if your emergency account gets depleted. Ugh, is all I can say right now. News of more home foreclosures from friends and more credit woes.

Kristen@TheFrugalGirl October 3, 2008 at 9:03 pm

We had a HELOC for the last couple of years for home improvements, but happily it is down to a zero balance, AND we have an emergency fund. Woot! Our HELOC is in no danger, though, because we have a ton of equity in our house. Still, I hope we never, ever have to use it again!

Paula: Stop Collection Calls September 25, 2009 at 11:36 am

We are constantly seeing people that think that their HELOC is a way to “pay themselves” for all the hard work of saving for their home.

Tragically, many find that they were very mistaken and the result is serious financial distress. Unfortunately, I work with individuals and families that are feeling this distress and it is often heart-breaking.

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