Using a HELOC as an Emergency Fund: Recession Life Hack or Risky Endeavor?

A photo to accompany a story about using a HELOC as an emergency fund Images by Getty Images; Illustration by Next Advisor
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What if, instead of a cash emergency fund, you had immediate access to a cheap line of credit without needing to apply or get approved? 

Would that be a recession life hack or a risky endeavor? 

A strong housing market and high inflation are leading some people to consider home equity as a backup emergency fund. 

The idea goes like this: If you currently have good credit, stable income, and equity in your home you can take out a home equity line of credit, or HELOC. Then, you’ll have an open line of credit to borrow against when a financial emergency arises. A HELOC can be an attractive product since interest rates are typically lower than those of credit cards and personal loans, and credit limits can be high because the loan is secured by your home. 

A HELOC can give you options in a crisis, even if it’s not a replacement for a cash emergency fund. There are risks and costs of the strategy, experts say, and a cash savings fund remains the gold standard for many planners. However, if handled carefully, a HELOC can provide an extra dose of flexibility for equity-rich homeowners who know how to take on debt responsibly. 

What Is a HELOC and How Does It Work?

Home equity is the difference between what your house is worth and what you owe on your mortgage. When you pay down your mortgage, or when your home’s market value rises, you gain home equity.  

A home equity line of credit (HELOC) or home equity loan lets homeowners tap into that equity for a cash infusion that they can use for almost any expense. In both cases, you’re taking out a loan secured by your home equity and must pay back what you borrowed, with interest, according to the terms of your loan agreement. 

While a home equity loan typically works as a fixed-rate installment loan where you receive the money in a lump sum and pay it back in fixed monthly payments, a home equity line of credit works a bit differently. You get access to a revolving line of credit that you can tap into whenever you want, for however much you want (up to the credit limit) for a certain amount of time, known as the draw period. Once the draw period is over, you’ll enter the repayment period and repay what you borrowed at a variable interest rate. 

“The benefit of a home equity line of credit is that you’re not borrowing the money just because you have the line,” says Isabel Barrow, director of financial planning at Edelman Financial Engines, a national financial planning firm. Rather, you have an open line of credit you can tap into anytime, and you only have to repay — and pay interest on — what you actually draw. This can be the entire line amount, or nothing at all.

Can You Use a HELOC as an Emergency Fund?

Most people take out a HELOC with a set purpose in mind for the funds. One common use for a HELOC is to fund home improvements, says Vikram Gupta, executive vice president and head of home equity at PNC. A second is to consolidate higher-interest debt.

“And then number three, which doesn’t get talked about much, is the rainy day fund,” says Gupta. “It is the emergency line of credit for when you need it.”

If you have good credit and sufficient equity in your home, you can open a HELOC to keep on hand for the length of the draw period, usually 10 to 15 years. If you have an emergency and need to borrow money, you’ll have immediate access to a line of credit at lower interest rates than credit cards, without needing to get a new loan. Since it typically takes a few weeks to two months to get approved for a new HELOC or home equity loan, having a HELOC on hand can ensure you’re immediately able to access the funds you need. And if you already have a HELOC open, you won’t have to worry about applying for and being denied a line of credit when you really need it. 

“You can absolutely have [a HELOC] for the entirety of the draw period and not draw down on it at all,” says Gupta.

While this isn’t the most common way to use a HELOC, it’s not rare. The percentage of HELOC lines that remain inactive in their first two years is around 30%, says Ken Flaherty, senior consumer lending market analyst at data analytics firm Curinos. Given the trends, Flaherty adds, it’s likely many who do not take a draw at closing never do. 

Sounds too good to be true? While this “life hack” does work as advertised and can be a good option for those who use it strategically, there are a few important caveats to be aware of.

Fees and closing costs

Like any loan, HELOCs can come with upfront fees and closing costs. Though many lenders will choose to waive them, it’s not a guarantee that your specific lender will. More common is an annual fee — typically between $0 and $100 — to keep the line of credit open. Some banks do not charge an annual fee, while others may waive it if you maintain a relationship with them through a deposit or investment account.

Some lenders will charge early closure fees, says Gupta, especially if the lender paid for any of the upfront fees or closing costs. If you close your HELOC before a certain amount of time — usually three years — has passed, you may have to pay back whatever closing costs the lender incurred on your behalf.

While you could get a HELOC to keep on hand at no cost, it’s far from guaranteed. It all depends on the lender you choose and the terms of your loan agreement. “You really have to read the fine print,” says Barrow.  

Pro Tip

Fees and closing costs can add another layer of complexity to shopping around for a HELOC lender, as the lender who’s willing to waive all upfront fees may not be the one offering the lowest interest rate.

A shorter repayment period

One benefit of a HELOC is the long loan term. Most HELOCs operate on a 30-year term, with a draw period ranging from 10 to 15 years and a repayment period ranging from 15 to 20 years. This means if you draw from your HELOC on the day you take it out, you could have up to 30 years (the entire draw period and repayment period) to pay back the debt.

That calculation changes if you borrow money near the end of the draw period. “If you open [a HELOC] and you don’t use it for 10 years, but then in the 10th year you decide you’re going to use it, you might have an accelerated payoff,” says Barrow. In this case, instead of having the full draw period and repayment period to pay off the balance, you’d only have the repayment period, which could lead to a higher monthly payment than you were expecting. 

A variable rate 

With a few exceptions that vary by lender, HELOCs are typically a variable-rate product. Unlike a home equity loan, where the interest rate you lock in at the beginning of the loan is fixed for the duration of the loan, the interest rate on a HELOC regularly adjusts based on the prime rate throughout the draw period and repayment period. 

“As interest rates go up, the rate that you’re paying on the home equity line of credit can go up, meaning your payment is not fixed,” says Barrow. This can be an issue if rates spike at the same time you’re using your HELOC to cover an emergency, and the minimum payment becomes more than what you can afford.

“If you do get a home equity line of credit, make sure you can afford to pay back the loan quickly if rates go up enough to warrant a change in your plans,” Barrow advises. 

Your lender could suspend your line of credit

The bank ultimately controls the line of credit — not you. When you’re depending on a HELOC to tide you through a financial emergency, the last thing you want is to have that line of credit cut off.

A HELOC involves a contractual agreement between the lender and borrower, says Gupta, so the lender can’t cancel a borrower’s line just because it wants to. But often, the loan agreement will contain provisions for a lender to protect itself if it’s worried about the borrower’s ability to repay the loan. 

“We monitor the customer’s credit over the life of the loan. If their credit drops, we can suspend their line, i.e. not allow them to access the line any further,” explains Gupta. “There is an obligation for the customer to largely maintain their credit — and this is disclosed in the contract.”

Before you close on a HELOC, make sure you’ve read the loan agreement and you understand the situations your lender is allowed to make adjustments to your line of credit. 

Should You Use a HELOC as an Emergency Fund?

You can use a HELOC as an emergency fund, but should you? A HELOC should never replace a cash emergency fund as your primary financial safety net, but if you have the home equity and can use a HELOC judiciously, having one available can give you one more option to choose from in a financial crisis. 

However, keeping a HELOC on hand doesn’t necessarily mean you should draw from it. If you have a financial emergency, you should consider all the risks, benefits, and alternatives to decide if using a HELOC is the best option for your specific situation. Here’s what experts want you to know:  

It’s better to have savings

Any form of debt comes with risk, and a HELOC is no exception. Even though the monthly payment is often much smaller during the draw period compared to the repayment period — especially if you have an interest-only HELOC — there’s still a minimum monthly payment you must meet. Since a HELOC is secured by your house, defaulting on the loan is especially risky compared to unsecured debt, as it means the lender could foreclose on your home.

“If you need money for an emergency, how are you going to then be able to make a payment on a home equity line of credit?” says Barrow. 

There may be emergencies where you need a quick cash infusion, but your current income and financial situation allow you to quickly repay any debt that you incur. “If you believe your emergency to be shorter-term in nature … I can see a home equity line of credit playing a role,” says Barrow. 

But if your emergency is something like a job loss or medical condition that will reduce or eliminate your income for a while, taking on debt secured by your home probably isn’t the best idea.

“In an ideal financial planning world, you are actually saving for an emergency fund separately from your home equity,” says Barrow. If you’re not currently in a financial emergency, building a cash emergency fund should be your top priority right now. 

When a HELOC makes sense

The other factor to consider is what alternatives you have available. 

If you have a true emergency and no emergency fund, an already established HELOC can be a better option than a credit card, which typically comes at a higher interest rate, says Barrow. 

It might also be a better option than liquidating your investments (especially in a down market) or drawing from your retirement savings

A HELOC could be a viable strategy for covering an emergency, as long as you understand the caveats and have looked into all your other options. But if you want to be financially prepared for the future, the very best option will always be to build an emergency fund before you ever need it. 

How to Build an Emergency Fund

Having a cash emergency fund can keep you from going into debt in the case of unexpected expenses. “That is the best way to get yourself into a secure position to insure against the unknown — especially as we are in a volatile stock market and an economic situation that we are unsure of in the future,” says Barrow.

If you don’t yet have a solid emergency fund, here are some tips to start building one

  • Set a goal: “The first step is to lay out that goal of how long you are giving yourself to build this emergency fund and just divide it out by month,” says Barrow. This will let you know how much you need to save every month. Experts typically recommend having three to six months’ worth of living expenses on hand in a fully-stocked emergency fund, but it’s fine to work towards that goal slowly and make monthly contributions that fit your budget. 
  • Automate your savings: After you’ve determined how much you need to save, set up automatic deposits into a savings account with every paycheck. If your goal is to build an emergency fund over the next three years, Barrow says, “figure out how much that’s going to take and just automate it. The chances are, you’re going to figure out how to live on whatever you have left.”
  • Audit your budget and cut expenses: “It’s very easy to get yourself into the mindset of ‘I can’t afford it,’ or ‘I don’t make enough money,’ or ‘my expenses are too high,” says Barrow. “There’s always things you can look at cutting back on, whether it’s your Netflix subscription or Spotify or not drinking the coffee every day, whatever it is.” 
  • Separate your emergency fund: To avoid the temptation of dipping into your emergency fund for non-emergencies, Barrow recommends separating it from your other assets. “What I like to suggest is to set up a completely separate savings account — even at a different bank — so you don’t see it all the time and it’s not as easy for you to access or transfer funds back into your checking account,” she advises. 
  • Keep your money in the right place: When you set up an emergency fund, “you’re really putting that money away with the idea that it’s going to sit there for a long period of time,” says Barrow. A high-yield savings account is perfect for this purpose, as it’s liquid enough for you to draw from immediately in an emergency, while not being too easy to tap into for everyday expenses. And, if you choose the right high-yield savings account, you can earn decent interest on your cash.