*This post was created in collaboration with Alpine Credits
Emergency expenses can pop up at any time, and they usually creep up at the worst times. While you could rely on your credit card or a personal loan if you don’t have enough cash in the bank, the interest rates on these financial products are typically quite high. This is especially true when compared to a home equity line of credit (HELOC) or home equity loan.
The question is, when does it make financial sense to borrow against your home equity for emergency purposes? And how do you go about tapping into your home equity?
Should You Use Home Equity As An Emergency Fund?
There are plenty of reasons why you might want to use your home equity as a resource to build an emergency fund:
Access Large Amount Of Money: You can tap into significant amounts of equity, which can be used to cover big unexpected expenses.
Lower Interest Rates: Home equity loans and HELOCs usually come with lower interest rates compared to unsecured personal loans or credit cards.
Flexible Payments: If you choose a HELOC, you can borrow as much or as little as you need, and can repay the funds on a flexible schedule.
Longer Repayment Terms: HELOCs and home equity loans can come with repayment terms as long as 20 years or longer, giving you plenty of time to pay off the loan.
| Note: Are the benefits of using home equity for an emergency fund worth the risk? If you don’t keep up with loan payments you risk losing it as your home acts as collateral. |
Types Of Home Equity Loans You Can Use In Emergencies
There are two main types of equity-based financing options that homeowners can use, each with distinct features:
HELOC
A Home Equity Line of Credit (HELOC) works like a revolving line of credit, where homeowners can borrow against the equity in their home, up to a certain amount. This type of financing provides flexibility, since you can borrow as much or as little as needed during the “draw period” (usually 5 to 10 years), during which you only need to make interest-only payments.
Following the draw period, you’ll enter the “repayment period”, where you’ll make regular principal and interest payments. The interest rate is typically variable, which can fluctuate over time. A HELOC can be used for a variety of ongoing expenses, including emergencies.
Home Equity Loan
Like a HELOC, a home equity loan allows homeowners to borrow against their home equity. Similar to traditional installment loans, a home equity loan provides a lump sum of money that’s repaid over a set term at a fixed interest rate. Payments include both principal and interest, and the loan is backed by the home.
The funds from a home equity loan can be used for various needs, including building an emergency fund.
Is A HELOC Or Home Equity Loan Better In Emergencies?
Both a HELOC and home equity loan offer similar benefits. However, there are certain advantages and disadvantages to each.
A HELOC can be a better option than a home equity loan because you’ll have instant access to the funds when you need them. With a home equity loan, you’ll need to apply for the loan when you need the money, which may take some time, something you may not have during an emergency. Moreover, you won’t accrue any interest till you withdraw the money and you can make interest-only payments till the draw period ends.
On the other hand, a home equity loan can prove more advantageous due to its fixed payments. Unlike a HELOC, a home equity loan comes with a fixed rate, not a variable rate, making it easy to budget for.
What Will Your Payments Be Like If You Use Your Home Equity As An Emergency Fund?
Your payments will depend on the loan type, the amount borrowed, and the repayment period. The following table provides a simplified comparison of monthly payments for a fixed-rate home equity loan and a variable-rate HELOC:
| HELOC | Home Equity Loan | |
| Loan Amount | $10,000 | $10,000 |
| Interest Rate | 7.5%* | 7.5%* |
| Term | 5 years (draw period) 5 years (repayment period) | 5 years |
| Monthly Payment | $62.5 (Interest only-payments during draw period) | $200.38 |
| Interest Paid | $3,750 (during draw period) | $2,023 |
| Amount owed after 60 months | $10,000 | $0 (loan is paid off) |
| Monthly Payments | $200.38 (principal + interest payments during repayment period) | $0 (loan is paid off) |
| Interest | $2,023 (interest paid during repayment period) | N/A |
*Note: Interest rates with HELOCs are typically variable, which means they can fluctuate over time. Given this, the interest-only payment amounts can also change. Further, principal payments will also be required once the draw period ends, however, you can choose to make more than the interest-only payments during the draw period.
Will You Qualify For A Home Equity As Emergency Fund?
The general requirements to qualify for a home equity loan or HELOC include the following:
- Adequate Home Equity: Lenders typically require that you have a minimum of 20% equity in your home.
- Credit Score: A good credit score is generally required to qualify for a home equity loan or HELOC. However, some lenders, like Alpine Credits, may focus on your home equity above all other factors.
- Sufficient Income: Lenders will want proof that you earn enough to cover your loan payments.
- Debt-to-Income Ratio: Not only do lenders look at the amount of debt you carry, but they also compare that debt load to your income.
- Property Value: Your lender may want to have your home appraised to verify its value.
Keep in mind that exact criteria can vary by lender.
What Kind Of Financial Emergencies Is A Good Reason To Use Your Home Equity?
Taking out a home equity loan or HELOC means adding more debt to the books. It also puts your home at risk if you fail to make your loan payments. Given this, you should only borrow against your home equity for good financial reasons.
Below is a list of some good and bad reasons to use your home equity:
Good Reasons To Use Home Equity For Financial Emergencies
- Home Repairs: Some home repairs are needed to ensure that the home is livable and safe. You may also consider improving your home to add value to it. In either of these cases, a home equity loan might make financial sense.
- Car Repairs: Cars are a necessity for many Canadians, especially when it comes to commuting to and from work. If your car is in need of repair and you don’t have the liquid funds to cover the cost, then a home equity loan may be suitable.
- Medical Expenses: Covering unexpected medical bills can be crucial, especially if it’s a type of expense that’s not covered by your provincial healthcare plan.
- Job Loss: If you’ve been laid off and need temporary financial relief while searching for employment, this may be a good reason to tap into your home equity.
- Education Costs: Funding educational opportunities may be a good reason to use your home equity, particularly if it leads to a high-paying job.
Bad Reasons To Use Home Equity For Financial Emergencies
- Vacations: Unless you need the money to travel for emergency purposes, such as getting to a family member in need, then trips paid with home equity are risky.
- Luxury Purchases: Purchasing non-essential items is not an emergency and therefore not a good reason to use your home equity.
- High-Risk Investments: Unless you can find a conservative investment vehicle that pays out a higher rate of return than the rate you’re paying on your home equity loan, using equity for speculative investments can unnecessarily put your home at risk.
Bottom Line
Using your home equity as an emergency fund can provide fast cash in urgent scenarios. But it’s always a good idea to carefully weigh the risks and benefits, especially since you’re using your home as collateral.
