HELOC as Emergency Fund

[growing_older]

In the past few weeks, we've witnessed America's largest lenders actually lowering the loan to value ratio on new home equity loans and even shaming many of their existing customers by substantially reducing their line of credit or worse yet cutting off life support altogether.

Over in the mortgage threads, there is much discussion of lenders restricting credit, even for prime borrowers. One of my FIRE plans has been to invest in tax advantaged accounts and pay off my mortgage and at the same time keep a HELOC for a possible source of emergency funds should it ever be needed. Is this still a viable plan, if the bank may unilaterally change the agreement? By keeping a relatively small emergency fund in cash, I feel like I am putting my money to work elsewhere, yet still have the HELOC to fall back on should a big emergency arise. What I am reading now seems to say this is riskier than I thought if the bank might refuse to extend funds as they previously agreed.

If this is real problem, then perhaps I should divert any money now paying off the mortgage into a larger cash emergency fund, in which case maybe the HELOC isn't needed at all. I am reluctant to devote new cash to this, when it seems the HELOC really should be doing this job, but can I really count on the HELOC. I never heard of banks refusing to extend credit under an agreement they had already made, but people do seem to be reporting that happening.

I can see it would be safer to accumute the savings. But what are the chances I really need that much safety? Is it becoming common for banks to withhold HELOC?

 

[youbet]

I am not aware of specifics regarding HELOC terms and conditions today. However, I'd assume that since banks NEED to loan money, HELOC's will continue to exist. Terms may become less favorable and if your agreement with the bank is on the edge of qualifying, I'd keep an eye on it.

Perhaps a compromise would be prudent. Put a few months of expenses into a cash holding, cover the rest with the HELOC.

 

[Sandy]

What I have heard happening is that banks are adjusting the HELOC loan amount based on reduced market value of the home. So, if you had a $150,000 HELOC on a home that is now only worth $120,000, the bank can reduce the HELOC to 80% of the lower value.

So, whether your plan poses a problem depends on the amount of cushion/loan amount you are looking for, relative to the value of your home.

 

[al_bundy]

over on creditboards last year there was someone who had a HELOC of close to $100,000 with something like a $40,000 balance from Citi. he complained that they pretty much canceled it by lowering his limit.

if you want to search for the thread, i think his username was liverichly (the irony)

 

[OAG]

Spoke to PFCU yesterday about another subject and actually did ask about any plans to lower our HELOC level and was told it would not change. We have a $100K HELOC (at 0 balance) which we only have as an "emergency" source of funds. So far no "emergency".

 

[Sue J]

We have a HELOC open at up to 50% of our home's value. We have no mortgage and no balance on the HELOC. I keep it open just for emergencies. It had a fee of $98 a year but the past 2 years I have called and explained that there is no balance and the fee has been waived.

This is a HELOC that we got in 2003 to pay off our 7% mortgage and do some home projects. The HELOC rate was 3.5%. Now, we just never closed it so that it can be an emergency fund.

 

[myself]

We're keeping $2,000 in a high interest savings account as an EF. We'll be building that up to 6 months after we finish paying off our car loan.
Right now, if the emergency is too big, we use CCs (but budget around so that it's paid in full).
We don't consider a lot of things emergencies. Unplanned vehicle repair is an emergency, medical (other than a doctor's visit here/there) would be an emergency. There are probably a couple things more but I can't think of them off the top of my head.
We wouldn't spend any of the $2,000 just because there's a small leak in the house, we'd just eat a little less, and fix the problem ourselves.
As for heater breaking down, I'd say it's an emergency, but ours is only 7 years old, along with the whole house.

 

[Nords]

Is this still a viable plan, if the bank may unilaterally change the agreement?
I can see it would be safer to accumute the savings. But what are the chances I really need that much safety? Is it becoming common for banks to withhold HELOC?

Sure, should work great. If a bank does more than diddle with the last couple digits of the max balance then you can always join PenFed for their lower interest rates.

That "3-6 month's expenses" rule of thumb isn't much better than the "80% of pre-retirement expenses" canard.

In the first place, if you lose a job then you're not going to keep merrily spending at your old rate-- you're going to slam shut the wallet and probably make the 3-6 months' emergency fund last for nearly a year.

If you're retired, you're rarely going to have an expense that's over $10K... maybe to buy a used car or drill a new well or dig up your septic tank or check out of the emergency room. You'll probably see the rest of the big-ticket expenses (a new roof, higher property taxes, a kid's wedding) coming from a few months away.

A HELOC is a great way to write a check and have a month or two to figure out how to come up with the money. Meanwhile the emergency fund can be broken into smaller longer-term CDs (like PenFed, which breaks them down into amounts as small as $1000) which you can break into only if necessary and then only the ones that are needed.

Another advantage to having a credit union HELOC is that they're unlikely to diddle with the terms of the agreement.

 

[myself]

Sure, should work great. If a bank does more than diddle with the last couple digits of the max balance then you can always join PenFed for their lower interest rates.

That "3-6 month's expenses" rule of thumb isn't much better than the "80% of pre-retirement expenses" canard.

In the first place, if you lose a job then you're not going to keep merrily spending at your old rate-- you're going to slam shut the wallet and probably make the 3-6 months' emergency fund last for nearly a year.

If you're retired, you're rarely going to have an expense that's over $10K... maybe to buy a used car or drill a new well or dig up your septic tank or check out of the emergency room. You'll probably see the rest of the big-ticket expenses (a new roof, higher property taxes, a kid's wedding) coming from a few months away.

A HELOC is a great way to write a check and have a month or two to figure out how to come up with the money. Meanwhile the emergency fund can be broken into smaller longer-term CDs (like PenFed, which breaks them down into amounts as small as $1000) which you can break into only if necessary and then only the ones that are needed.

Another advantage to having a credit union HELOC is that they're unlikely to diddle with the terms of the agreement.

All true.
But out of curiosity, don't retired folks also get those low rate CC offers too? That could easily allow for a couple of months to get over things that happen to come up, without risking one's house.

 

[jIMOh]

Over in the mortgage threads, there is much discussion of lenders restricting credit, even for prime borrowers. One of my FIRE plans has been to invest in tax advantaged accounts and pay off my mortgage and at the same time keep a HELOC for a possible source of emergency funds should it ever be needed. Is this still a viable plan, if the bank may unilaterally change the agreement? By keeping a relatively small emergency fund in cash, I feel like I am putting my money to work elsewhere, yet still have the HELOC to fall back on should a big emergency arise. What I am reading now seems to say this is riskier than I thought if the bank might refuse to extend funds as they previously agreed.

If this is real problem, then perhaps I should divert any money now paying off the mortgage into a larger cash emergency fund, in which case maybe the HELOC isn't needed at all. I am reluctant to devote new cash to this, when it seems the HELOC really should be doing this job, but can I really count on the HELOC. I never heard of banks refusing to extend credit under an agreement they had already made, but people do seem to be reporting that happening.

I can see it would be safer to accumute the savings. But what are the chances I really need that much safety? Is it becoming common for banks to withhold HELOC?

Here's a discussion on another board on this very subject.

misc.invest.financial-plan | Google Groups#

 

[liveitup]

Freezing equity lines is becoming common practice as the credit crunch worsens.I hated to do it,but I withdrew funds from one of my HELOC's and deposited it in a money market account.It's costing me about 2%(prime rate minus mm yield),but I don't have to worry about it being frozen and not having access to the funds.I'll check my fico score in a few weeks to see if it has an impact.

 

[Moemg]

Freezing equity lines is becoming common practice as the credit crunch worsens.I hated to do it,but I withdrew funds from one of my HELOC's and deposited it in a money market account.It's costing me about 2%(prime rate minus mm yield),but I don't have to worry about it being frozen and not having access to the funds.I'll check my fico score in a few weeks to see if it has an impact.

Not only did they not freeze mine they offered to move it up to $180,000 from $60,000. I declined .

 

[maddythebeagle]

All true.
But out of curiosity, don't retired folks also get those low rate CC offers too? That could easily allow for a couple of months to get over things that happen to come up, without risking one's house.

Yeah, you can do that......I think the issue is folks end up maxing out cards effectively locking themselves out of new offers once the others expire...but I think the intelligent on this board could handle it... I like to add a couple of 0% purchase cards every 6 months or so to have on hand...

 

[brewer12345]

I can't say I am real worried about it. Generally speaking, if you are not set up for more than 80% CLTV and you have good credit and not too much debt, most banks will leave you alone, especally if you have other products/relationship with the bank and aren't in a disastrous RE market. But even so, I would never want to rely on just a HELOC for liquidity in a pinch. You definately want to keep some cash around, and its nice to have taxable investments you can borrow against or liquidate if you really need to.

 

[RonBoyd]

There is an interesting article in the March 2008 issue of Consumers Reports entitled "Your Mortgage: It Rarely Pays to Prepay.

"It is also available online at ConsumerReports.org - Prepaying your mortage: When to prepay and when not to (This may require a subscription -- I am unsure.)

The article Begins:

"Few Americans may burn their paid-off mortgages anymore, but many of us get a warm feeling thinking about the day that the biggest financial obligation of our lives will finally be behind us.

While paying your mortgage is definitely a good idea (the alternative being possible foreclosure), whether to take cash you might otherwise invest and pay the loan off ahead of time is a trickier calculation. The decision has become even more complex lately given the ups and downs of the stock market and the downs and more downs of the housing market.

We decided to put that choice to the test in the Consumer Reports Money Lab."

Something to think about in this thread.

 

[liveitup]

Not only did they not freeze mine they offered to move it up to $180,000 from $60,000. I declined .

A couple of hours after I made the withrawal,the bank emailed to remind me that I have available funds remaining in the account.I guess they really want my business,but in this environment that can change real quick!

It's better to have it and not need it,than to need it and not have it!

 

[rayvt]

A HELOC is not an emergency fund. Every HELOC I've had (two) had a clause right there in it that said the bank could decline to advance you any money whenever they wanted to.Better not count on taking a draw and depositing the money into another account at the same bank, either. There was also a clause giving them the right to offset---take money from another of your accounts and apply as a payment to the HELOC.

 

[cute fuzzy bunny]

There is an interesting article in the March 2008 issue of Consumers Reports entitled "Your Mortgage: It Rarely Pays to Prepay.

Yeah, and you oughta see the letter I wrote them about their hopelessly myopic perspective on the matter, and the areas where they royally screwed up or didnt give enough information.

They wrote me back, and one of their editors is going to be talking to me next week about a revision to the article with more information and some different conclusions...

Besides not talking at all about risk adjustment to the various approaches, the article is pitched towards a wage earner, not a retiree. It was the classic error of reducing the situation to the most simplistic "I can make xx% over here over 30 years and it only costs me yy% to fund that arbitrage". Thats fine if thats as complex a situation as you feel comfortable with looking at and if you make all your financial decisions in close set binary and if you can watch your investments bounce around like a rubber ball while your house is on the line without making any changes to your AA.

Wage earners with a 10+ year horizon before retiring oughta have a mortgage and invest as much as they can. Retirees...a lot harder to make the case.

 

[W2R]

A HELOC is not an emergency fund. Every HELOC I've had (two) had a clause right there in it that said the bank could decline to advance you any money whenever they wanted to.Better not count on taking a draw and depositing the money into another account at the same bank, either. There was also a clause giving them the right to offset---take money from another of your accounts and apply as a payment to the HELOC.

Good point - - I took out a HELOC for an emergency fund a couple of years before I finished paying off my house, and found (much to my dismay) that the fine print gives them all kinds of outs, especially if your financial situation changes (as in an emergency, I suppose). If I used it in such a situation, I would know that if they found out what was going on I'd be in trouble. I haven't ever used it, and I should probably cancel it now since I don't need it.

 

[Notmuchlonger]

Im not sophisticated enough to take out a HELOC. We paid off the house and live within our means. Im sure that I missed out on some great debt investing. However, I am too chicken to do that sort of thing.

 

[growing_older]

Thanks for the great info. Several people mentioned that the "most likely" reason for my bank to freeze a HELOC would be if the house value dropped and the credit line put me near or over the reduced house value. I don't think I have to worry about that as house value is way above HELOC limits, but I am worried about other scenarios, such as bank is generally tightening these kinds of agreements, emergency includes loss of job and bank uses that as reason to freeze account, other reasons besides creditworthyness that might shut off credit line just when it's needed. Any sense of how real any of these dangers are? Scare stories in financial press about credit tightening have got me concerned, but I'm having difficulty determining if any of it applies to my situation or not.

 

[RonBoyd]

Yeah, and you oughta see the letter I wrote them about their hopelessly myopic perspective on the matter, and the areas where they royally screwed up or didnt give enough information.

They wrote me back, and one of their editors is going to be talking to me next week about a revision to the article with more information and some different conclusions...

Well, good on ya. I felt it was a little shallow but was unsure why. Did you address your letter to the Editor? -- they may print it. In any event, I will be waiting on their response.

Disclosure: I have a HELOC and have used it often for just such purposes. It is my only mortgage and currently has a zero balance. Nevertheless, I would use it in a heartbeat if I thought it useful. It is a source of funds with relatively low cost and certainly convenient. Risk, of course, is determined on a case by case basis.

 

[mathjak107]

helocs can be a real problem for emergency source of funds. im still trying to figure out how most people can afford to pay a loan back at the same time they are in a cash crunch. i think there are very few situations for most where counting on the heloc as the same has having had your own real cash will be a better idea... the only people who should do this are those that have the money and dont really need the loan but do so out of convience more than necessity. if you have lots of assets and can liquidate them in a heartbeat to pay the loan back then i can see it

 

[liveitup]

A HELOC is not an emergency fund. Every HELOC I've had (two) had a clause right there in it that said the bank could decline to advance you any money whenever they wanted to.Better not count on taking a draw and depositing the money into another account at the same bank, either. There was also a clause giving them the right to offset---take money from another of your accounts and apply as a payment to the HELOC.

Im my situation a HELOC is more of an investment tool,than an emergency fund.I invest in real estate and the bulk of my properties are free and clear and cashflow nicely.Quite frankly I hate debt,but without the leveraging power of money,I'd still be a wage slave.

 

[RonBoyd]

helocs can be a real problem for emergency source of funds. im still trying to figure out how most people can afford to pay a loan back at the same time they are in a cash crunch. i think there are very few situations for most where counting on the heloc as the same has having had your own real cash will be a better idea... the only people who should do this are those that have the money and dont really need the loan but do so out of convience more than necessity. if you have lots of assets and can liquidate them in a heartbeat to pay the loan back then i can see it

The problem with your own funds as "emergency cash" is: where do you put it? No matter how you look at it, this money would be lying fallow somewhere and, after all, you may never need it. I believe this has to do with something called "opportunity" cost.

In any event, "emergencies" take many forms not all of which shut off income (cash flow) forever -- including that worst of all emergency, a HD TV on sale. Most HELOCS allow you to determine your own repayment schedule (after, of course, some very minimal amount). This allows one time to recover from any emergency without it turning it into a Disaster. As "LiveItUp" just said, without leverage we would all be digging ditches... until we died.

Having said all that, it is good to keep in mind that you are placing your home at risk with a HELOC and act accordingly. "Never forget the Dragon when you live near one."