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| Tuesday, March 07, 2006 |
| Home Equity as Emergency Fund? |
Nina over at Sitting Pretty posts about using your home equity as your emergency fund. I admire Nine and generally agree with her, but not on this topic. While I agree that having an adequate Emergency Fund is step one in "How to protect yourself from life's cruel little surprises", I am not a fan of using your home equity as your primary defensive maneuver.
For me, my home currently serves two purposes. I live in it and it generates income via my basement tenant. True the income goes directly to helping me pay my mortgage, but it is income none the less. Would I really want to add a third purpose to my home? That of emergency ATM? For me the answer is no. I would far rather figure out other ways to save cash for that emergency day.
Because if the emergency should be a protracted one I would not want to risk losing both a portion of my income and the roof over my head. So yes, get ye an Emergency Fund post haste - but please save for it if you can. Don't over-leverage your assets.
Update with Question - Does having an open Home Equity line of credit impact your credit score? |
| posted by Boston Gal @ 11:16 AM *
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| 8 Comments: |
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Could not agree more. Relying on an equity line for emergency savings is very risky. In addition to whatever disaster caused you to need some emergency savings, now you are deeper in debt, and you home is at risk.
If you want to live dangerously, get a bunch of high-rate high-limit credit cards for emergency use. At least the debt is unsecured.
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Jane, I agree with the logic of your posts about 99% of the time, but on this one I'm with Nina. No one should rely on home equity as a principal source of emergency funds, but setting up a home equity line of credit is still a smart move. As Nina notes, once you're in trouble it's too late, no lender will loan you money. At that point, you risk being compelled to sell your home when you exhaust your liquid assets and the mortgage is due.
Having a home equity line of credit costs nothing until you use it. If you can keep your hands out of the proverbial cookie jar by not using it as an ATM, it can provide a layer of self-insurance against catastrophe.
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In my opinion...perhaps not as the primary emergency fund but if that is all you've got, then you better be prepared and set it up. =)
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Jane, this topic seems to come up often and I completely agree with you. You can not count on that line of credit when your home (the collateral for your HELOC) is destroyed.
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Having an open home equity line of credit can impact your credit score.
Positively: since a home equity line of credit is a revolving line, it increases your total available credit. This in turn lowers your utilization (total revolving balances divided by total available credit). Optimum utilization to make the ‘FICO powers that be’ happy is 30% or less. Higher available credit limits lower your utilization, assuming all other outstanding balances remain steady or decrease.
Negatively: if/when the home equity line of credit is used, it does the exact opposite of the above…increases your utilization. FICO calculates utilization by each revolving line, as well as an aggregate total of all revolving lines. If the home equity line of credit is $50k and you use $25k, the utilization for that revolving line is 50% (25/50) which could negatively impact your FICO scoreds, (a little or a lot) depending on your total credit picture.
So to really answer your question, it depends. :-)
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Thanks SingleMom - that was a gold star answer to my question!
I am still against HELCO's, but I can see why others find them useful. If just having an open credit line is free to optain AND does not hurt your credit score it may work for folks. I would still rather just save the Emergency fund.
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FICO is so messed up... most of the borrowing I have ever done is margin loans against stock and none of it shows up on my credit report. Neither do they take account of assets or income just history of payments...
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I have to agree with John Omm. It differs for everyone, but if you have in Boston, chances are you have a significant amount of equity in your home. Even if you just put down 20% to avoid PMI that could easily leave you 100K that could tapped if you get 95% line. For a lot of people this could represent over a year of an emergency fund without getting close to the "losing my home" point. And if it's not your only emergency fund, then it shouldn't be problem.
I prefer to use my equity line as my emergency fund so that I can have more money in the active investments theoretically making more money for me in the long haul. If I have to build up 50K in cash for emergency, it will be a few years before I get anything invested in my future. However, if I invest now, between having that as it's own emergency fund and my HELOC, I feel okay. Really the only thing that could happen is a perfect storm of Total stock, bond, foreign, market collapse (which would hurt my investment side), real estate market collapse (which would hurt the value of my home if I did need to sell), and a prolonged loss of job for a period of around two years. Then again if all those things happened, a regular emergency fund would be done as well.
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Could not agree more. Relying on an equity line for emergency savings is very risky. In addition to whatever disaster caused you to need some emergency savings, now you are deeper in debt, and you home is at risk.
If you want to live dangerously, get a bunch of high-rate high-limit credit cards for emergency use. At least the debt is unsecured.