The problem
A prudent Fool is supposed to have an emergency fund at hand at all times, just in case something unpleasant happens to your financial situation. You've heard it all before: save up and set aside at least three months' worth of living expenses, and you'll be OK under most circumstances, even really difficult ones.
And you mean to do it, but no matter how many pennies you fish out of the couch cushions, you just can't seem to get ahead. And so you live under a constant Sword of Damocles, with nothing to fall back on if disaster strikes and you can't earn a paycheck for a few months.
Though you have a decent amount of equity built up in your home, there is no way you're going to take out a home loan just in case you might need the funds later. The interest payments are reason enough not to take that step.
The solution
Allow me to introduce you to the Home Equity Line of Credit, known to friends as the HELOC. It's a different form of home equity-based financing, with several features that qualify it as a solution for the troubled situation I just described.
Like a regular home equity loan, the HELOC is a second mortgage with potentially high levels of funding available, especially in a booming housing market that has seen your home value skyrocket over the last few years, not to mention the tax advantages of second mortgages.
But apart from the source of the funds, the two funding options couldn't be more different. A HELOC acts more like a credit card than a loan, albeit a card with huge credit limits, low interest rates, and very favorable repayment terms.
In a nutshell, you can start up a HELOC with your favorite credit union or bank, ranging from the Citibanks (NYSE:C) and Bank of Americas (NYSE:BAC) of the world down to local operations like Bank of the Ozarks (NASDAQ:OZRK) or Mercantile Bank of Michigan (NASDAQ:MBWM). Then you tuck the account away somewhere safe and forget all about it.
The benefits
Assuming you got a HELOC without annual fees (and there are plenty of them out there), it will cost you nothing to have that safety net lying around until you need it, unlike traditional loans. If and when you do need to use it, the credit line should be plenty big enough to support you for three to six months, or even longer, if need be.
Just make sure you stay disciplined about using the credit line. It's not there for buying iPods or raising your current standard of living. It's for emergency use only, and as long as you stick to that rule -- like gravel to dropped chewing gum -- you'll be fine. No matter what happens, or when.
Further Foolish Reading:
- Motley Fool GreenLight has plenty more to say on the subject.
- Fellow Fool Tim Beyers has some firsthand experience ...
- ... and so does another colleague, Alyce Lomax.
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Fool contributor Anders Bylund is about to start up a HELOC of his own, just in case this whole writing gig doesn't work out. He owns shares in Bank of America but holds no position in any other company mentioned. Fool rules are here .
