Can You Use a HELOC as Your Emergency Fund?

We all need money for a rainy day -- but will a home equity line of credit suffice?

You never know when a financial emergency might arise, whether it's a leaky roof, a busted car engine, or a medical issue that makes you miss work and causes you to rack up countless bills. That's why you should always have access to cash in a pinch, and that's where your emergency fund comes in.

Ideally, your emergency fund should contain enough money to cover anywhere from three to six months of essential living expenses. And you'll often hear that the best place to stash your emergency cash is in a savings account, where your principal is protected from losses.

But what if you have the option to use your home as a source of cash? If you have enough equity in your home, you can apply for a home equity line of credit, or HELOC, and secure a stream of money for the future. The question is: Can that actually take the place of an emergency fund?

How HELOCs work

Equity refers to the percentage of your home you actually own, and you can figure out what your equity is by taking the current value of that property and subtracting what you owe on its mortgage. For example, if your home is worth $200,000, and you owe $120,000 on your mortgage, you have $80,000 worth of equity. 

Once you have equity in a property, you can borrow against it via a home equity loan or a HELOC. With the former, you borrow a lump sum of cash and then start paying it back. With a HELOC, you don't necessarily borrow money initially. Rather, you secure a line of credit that's yours to tap into when you want or need to. For example, you might get a HELOC worth $20,000, and that allows you to withdraw some or all of that sum as necessary. 

Can your HELOC be your emergency fund?

Though HELOCs are a good way to access money in a pinch, yours shouldn't take the place of an actual emergency fund that's housed in the bank. For one thing, when you tap your HELOC, you become liable for interest on the money you borrow. And unlike home equity loans, which generally carry fixed interest rates, the interest on HELOCs is often variable, which means you could get stuck paying a lot of extra money for the privilege of accessing that line of credit. 

Another thing to consider is that the amount you're allowed to borrow via your HELOC could change if your home value declines. And the window of time to draw down a HELOC isn't unlimited -- you may only get five years from the time you're approved for it, which means you're out of luck if a major catastrophe strikes five years and two months after the fact. On the other hand, if you put a lump sum of money in the bank, you get the peace of mind of knowing exactly how much cash you have available, and that it's available to you indefinitely (as long as you don't withdraw it, of course). 

Finally, though HELOCs are relatively easy to qualify for, provided your home equity is there, and they generally charge a lot less interest than what you'll pay on a credit card or even a personal loan, you should know that if you fail to repay what you borrow, you risk losing your home to foreclosure. Granted, that is a risk whether you use your HELOC for emergency fund purposes or to do renovations, but it's something to think about. 

While it's not a bad idea to secure a HELOC and use it as extra protection in the face of life's unknowns, that HELOC should supplement an existing emergency fund rather than replace it. If you're sitting on loads of equity in your home, you can think about socking away three months of living expenses in the bank rather than six months' worth, and then securing a HELOC as well. That way, you'll have some cash on hand, coupled with a means of accessing more should the need arise.