It’s important to have an emergency fund in case of financial emergencies, but this is a struggle for many Americans. In 2022, the Consumer Financial Protection Bureau estimated 24% of Americans had no emergency savings, and another 39% had less than a month’s worth of income saved.
Despite that shortfall in cash, homeowners nationwide have experienced massive upticks in property values. The average equity per borrower in the U.S. reached $300,000 in 2022.
One way for homeowners to unlock that asset is to use a home equity line of credit (HELOC) as a savings buffer in case of an emergency.
In this guide:
- Can you use a HELOC as an emergency fund?
- Pros and cons of using a HELOC as an emergency fund
- What emergencies can I use a HELOC for?
- How long can I keep my HELOC emergency fund open?
- How do I determine which HELOC is best?
Can you use a HELOC as an emergency fund?
A HELOC offers access to a credit line up to a certain limit based on a percentage of your home equity and ability to repay the outstanding balance (according to your income, other debts, and credit score).
When using a HELOC as an emergency fund, you draw on the credit line as needed. This differs from a home equity loan, which gives you a one-time lump sum, making it less suitable for emergency funding.
You can access the HELOC funds in one of two ways:
- Via transfer to your bank account
- Your bank issues a credit card attached to your HELOC
Interest accrues on your outstanding balance. You can repay your balance and replenish your available credit, just like a traditional credit card.
The typical draw period lasts 10 years, followed by a repayment period that lasts several years.
Pros and cons of using a HELOC as an emergency fund
A HELOC can be a convenient way to prepare for a financial emergency, but please ensure you’ve also considered the drawbacks.
- Fast access to a large sum: If you experience a major medical event or get laid off, a HELOC could provide several months of living expenses.
- Acts as a safety net: You can open a HELOC but never use the funds. This safety net provides peace of mind for borrowers without large cash savings. You can use your money for other purposes, such as retirement savings or college tuition.
- Low-interest financing: Because a HELOC is based on your home equity, interest rates tend to be low compared to other types of financing.
- Interest-only payments during the draw period: Most HELOCs only require you to pay interest during the draw period, and then you’ll make full payments once that period ends.
- Possible tax deduction on interest: You may be able to claim the interest you pay as a tax deduction if you use your HELOC for IRS-approved home improvements. Note that the maximum interest you can deduct is $750,000, combining your mortgage and HELOC.
- It’s a type of second mortgage: Your home acts as collateral for a HELOC. If you fall behind on your payments, you risk foreclosure.
- Interest rates are often variable: Variable HELOC rates are subject to change. If interest rates rise, you could owe more than expected.
- Financing fees: As with any home loan, you’ll likely need to pay closing costs on a HELOC. You may also need to pay for an appraisal to confirm the value of your home. Some financial institutions also charge an annual fee to keep a HELOC open.
What emergencies can I use a HELOC for?
HELOCs have many uses, including emergency situations. There are no restrictions on how you can use a HELOC, so you’ll have plenty of flexibility.
However, that flexibility makes it easy to draw more than you need. Before you open a HELOC, give yourself parameters on what you consider an emergency situation.
Experiencing a medical emergency or losing a job are more clear-cut. But what about upgrading your car because it’s getting older? What kind of home repairs do you consider needs versus wants?
Create a clear plan to determine when to use a HELOC for an emergency and when it’s better to use cash savings or go without.
How long can I keep my HELOC emergency fund open?
Most HELOCs come with a draw period of five to 15 years followed by a repayment period of up to 30 years. You can no longer borrow funds at the end of the draw period. From there, you’ll start paying off the principal and interest.
You’ll likely see one of the following types of repayment when you get the terms of your offer from a lender:
- A balloon payment that requires you to pay the full balance at the end of the draw period
- A monthly payment plan over the course of several years
If you never use your HELOC or pay off the balance in full during the draw period, you won’t need to repay anything. But you might still need to pay relevant fees, such as account maintenance or inactivity fees.
How do I determine which HELOC is best?
Before applying for a HELOC, ensure you understand the application process. Requirements vary by lender, but you can expect yours to consider the following:
- Credit score
- Loan-to-value ratio (Most lenders only let you borrow a portion of your equity.)
- Debt-to-income ratio
It’s worth the time to shop around for the best HELOC rates and lenders to find your lowest-cost options. Start with lenders that offer online preapproval without a “hard” credit check.
Check each lender’s appraisal requirements. Does an appraiser need to come to your home and evaluate its current value? Does the lender use local real estate data to determine your home value? This can affect the timing of the loan approval process.
Alternatives to HELOC for an emergency fund
A HELOC isn’t the only way to build an emergency fund. If it doesn’t seem right for you, consider the following options.
Many experts recommend keeping three to six months’ worth of your basic living expenses in an emergency fund. It may take time to reach that threshold, but you can start by saving $500 to $1,000 in cash—enough to cover smaller emergencies, such as an emergency room visit or a car repair.
Many credit cards come with high interest rates and can be difficult to pay off with no set repayment period. However, if you have decent credit, it’s easy to get approved regardless of your home equity. Another benefit is that credit cards are unsecured, which means you’re not using assets (such as your home) as collateral.
Individuals with a 401(k) retirement account through their employer can borrow against those savings using a 401(k) loan. In 2022, the use of these loans increased by 24%. This indicates more people needed the money amidst economic uncertainty.
If you use a 401(k) loan, you can avoid the early withdrawal penalty without worrying about a long application process. Payments come out as automatic paycheck deductions.
However, you risk jeopardizing your retirement savings and the portfolio growth you may have experienced during the loan period.
And if you leave your job for any reason, you often need to repay the loan in full by the following year’s tax deadline, or the funds are treated as an early withdrawal, subject to taxes and penalties.