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Eventually, everyone has a financial emergency. It might be a surprise car breakdown on the way to work or a sudden repair required for a furnace in the middle of winter, but unexpected and urgent costs tend to arise at the worst possible time. In most cases, people aren’t ready for them financially. In fact, less than 40 percent of people currently have $1,000 in savings to cover one of these types of financial emergencies. If you don’t have money in your bank account to deal with an unexpected expense, what other options are there? One option many people turn to during financial emergencies is a home equity line of credit or HELOC for a financial emergency.
HELOCs are an open credit line, like a credit card, secured by the equity in your home. Depending upon your situation, a HELOC can be a good choice for dealing with a sudden and urgent expense. However, there are some disadvantages and risks to using a HELOC, so they’re definitely not for everyone. Here are a few important things to think about before you choose a HELOC for a financial emergency.
HELOCs for Financial Emergencies, the Pros
When faced with an emergency, sometimes any option is a good option. Beyond that though, there are some definite positives to a HELOC in this situation.
Big Enough for Most Financial Emergencies
If you have a costly financial emergency, a HELOC can be of great help. In most cases, if you’ve haven’t already drawn upon the equity in your home, you’ll be able to get the money you need to handle most emergencies. The limit on a HELOC is typically 80-85% of the appraised value of the house less the amount that’s still owed on the mortgage. For instance, if the home appraises for $300,000 and your mortgage balance is $200,000, then the HELOC limit would be $80,000 or so. This should be more than enough money to deal with nearly any unexpected expense.
Lower Interest than a Credit Card
People often use their credit cards to pay for emergency expenses. However, if they can’t pay off the credit card balance immediately, then massive amounts of interest can accrue quickly. Credit card interest rates are often high, too. Conversely, since a HELOC is secured using your home, it’s considered a lower risk loan and normally has a lower APR. As a bonus, you may be able to deduct your HELOC interest expenses when you file your Federal income tax return.
HELOCs for Financial Emergencies, the Cons
As expected, there’s a dark side to every bright side, and HELOCs are no different. In reality, there are quite a few dark sides to consider here.
You Need to Have It When the Emergency Strikes
If you don’t already have a HELOC when your sudden expense comes up, then you’re probably out of luck. It takes some time to apply for and establish a home equity line of credit since the lender will have to verify your equity prior to loan approval. It may take several days or even weeks to have the funds available. In most cases, emergency expenses need to be dealt with immediately, so waiting for a HELOC approval won’t work, so you’ll have to consider other options to pay the expense.
Limited Draw Period
Most home equity lines of credit have a specified drawing period. You can only withdraw from the HELOC for a designated amount of time, usually 5-10 years, and then the drawing period closes. Once the drawing period closes, you can’t withdraw any additional funds and must focus on repaying it. In the unfortunate event that your emergency arises outside the draw period, you’d be out of luck.
You Put Your Home at Risk
A HELOC is a secured line of credit that uses your home as collateral for any money that’s withdrawn. While the secured aspect of the HELOC usually means a lower interest rate, it also puts your home at risk. If you’re unable to make payments on funds you withdraw on your HELOC, the lender could put your home into foreclosure in pursuit of debt repayment. If your employment or financial situation is uncertain, you should definitely think twice before using a HELOC to deal with financial emergencies.
HELOCs can be a good option for dealing with financial emergencies. However, you need to have a HELOC to start with, and there are risks to drawing funds on your HELOC to deal with unexpected expenses. Consider the points brought up here if you have an unexpected expense come up and are trying to determine the best way to pay for it.
You should check out this great video as well, which discusses the pros and cons of using a HELOC for a financial emergency.