13 Sep Is HELOC a good emergency fund?

Q. I haven’t been able to build an emergency fund, but not for lack of trying. I just dip in all the time. Is a home equity line of credit good enough?
— Trying

A. Before we get to your question, let’s talk about what an emergency fund is supposed to be.

An emergency fund is a pool of funds that can be used during a financial emergency, said Taylor Thomas, a certified financial planner with Round Table Wealth Management in Westfield.

He said financial emergencies come in many shapes and sizes, but when speaking with clients about an emergency fund, he typically focuses on the threat of income loss.

“The size of the fund depends on the client’s personal situation: married vs. single, both spouses employed or only one, type of income — salary vs. commissions — and the amount of income being earned,” Thomas said. “In light of these factors, I will work with a client to come up with a target balance for their fund.”

Usually, the target balance is equal to some multiple of what the client’s monthly expenses are, he said.

Depending on the situation, a client should have three to 12 months’ worth of expenses saved up in their emergency fund, he said.

If the clients are married and both have jobs that pay compensation as salary, maybe they only need three to six months of expenses saved up. On the other hand, if a married couple only has one income and that income is in the form of commissions —which can be variable — maybe they should have six to 12 months of expenses saved, Thomas said.

Thomas said he would be nervous to see you rely on a home equity credit line to replace income.

The main reason is cash flow.

“As you draw on the equity line and increase the outstanding balance, your monthly fixed expenses will likely go up as the required interest payments on the equity line increase,” he said. “This will make it harder to cover your monthly expenses.”

He said using an equity line as an emergency fund defeats the goal of having an emergency fund in the first place. An emergency fund should take pressure off of cash flow, not the opposite.

He said you might find it helpful to complete a basic budget in order to outline income and expenses with the hopes of reducing the amount of times you need to dip into the emergency fund savings account.

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This post was originally published in September 2017.