Should you use a HELOC as an emergency fund?

Unexpected expenses have a way of showing up at all the wrong times. A car repair, a medical bill, or even a short stretch without work can quickly throw your finances off balance. That’s why having an emergency fund—even a small one—can make such a difference.

Saving up an emergency fund is often easier said than done, though. So, if you have equity in your home, it makes sense you might wonder if a home equity line of credit (HELOC) could serve as your emergency fund instead of, or in addition to, what you can save up. 

While a HELOC can be a good tool to pay for a home improvement project or consolidate high-interest debt, they're typically less ideal for an emergency fund. Let's explore using a HELOC as an emergency fund and alternatives that might be better options.

Can a HELOC be used as an emergency fund? 

A HELOC is a revolving line of credit secured by your home. This means you can borrow money, repay it, then borrow again, as much as you want up to your credit limit during the draw period. The draw period typically lasts five to ten years, depending on the loan.

HELOCs usually allow you to use your money for any purpose, whether it's home renovations or emergency expenses. So, it's possible to use a HELOC as an emergency fund during the draw period—if you qualify for one. 

To qualify for a HELOC, you generally need:

• Home equity—the exact amount depends on your lender, but usually a minimum of 15%, and many lenders prefer 20%

• A credit score of at least 600 (a few lenders may accept lower scores)

• An eligible debt-to-income ratio 

• Proof of steady income

HELOC approval isn’t guaranteed. Even if you have enough equity in your home to qualify, you may be turned down if your credit score is too low or you have too much debt already. It's also risky, since your home acts as the security or collateral for the loan. If you can't make your payments, your home could be at risk.

But you can't be denied an emergency fund. If you save up that money, it's yours to use whenever you need it. It's also very low risk, especially when you keep it in a high-yield savings account covered by the FDIC.

Pros of using a HELOC for emergencies

There could be certain benefits to using a HELOC for emergencies:

• You may get a much higher HELOC limit than you're able to save in cash.

• HELOC interest rates are typically much lower than credit card interest rates.

• You only pay interest on the amount you withdraw, though many lenders have a minimum draw and some may require a 100% initial draw.

Risks of relying on a HELOC as your emergency fund

Using a HELOC for emergencies could make sense, but there are some risks:

• HELOCs generally have variable interest rates, which could mean your payments rise over time.

• Your home is collateral for your HELOC, and failing to make payments could put you at risk of losing your home.

• Using a HELOC to cover an emergency expense means taking on debt, as opposed to using your savings and not adding to your debt.

• HELOCs cost money, both in fees when you open the account and interest when you borrow. In contrast, money you save and keep in a high-yield savings account could earn interest and make you money.

HELOC vs. traditional emergency fund

A HELOC could be your emergency fund in a pinch, but cash in a savings account is the better option in a lot of cases. Let's look at using a HELOC as an emergency fund versus a cash emergency fund to understand how the two compare.

When a HELOC makes sense as a backup

A HELOC as an emergency fund could make sense if you have a steady income, a lot of home equity, and minimal debt that's easy to manage. For the most part, a HELOC is best used as a backup emergency fund, not your primary emergency fund.

Cash in the bank is certain. A HELOC isn’t. If you happen to have a HELOC for another purpose, it could certainly serve as a secondary emergency fund if you need it. A more ideal situation is to have a cash emergency fund, with your existing HELOC a backup emergency fund in case you're faced with a large expense or you deplete your cash savings.

Alternatives to consider

The best alternative to a HELOC as an emergency fund is an actual cash emergency fund you keep in a high-yield savings account. It’s best not to invest your emergency savings in assets whose value can rise or fall. 

Other alternatives to a HELOC as an emergency fund include:

• An unsecured line of credit

• A hardship withdrawal from a retirement savings plan

• A credit card you reserve for emergency expenses