Does it make sense to keep your emergency fund in a HELOC?

For a change, a personal finance post, not a technical one.

There’s this idea that you can use a Home Equity Line Of Credit (HELOC) as your emergency fund, and pocket (or invest) the difference between the interest rate on your mortgage and the interest rate of wherever your emergency fund was sitting. It takes a lot of discipline and is definitely not worth it if you are going to tap the HELOC just because the money is there, not because you have a genuine emergency – and is only worth it if tapping your emergency fund is unlikely, because you have stable employment.

MoneyMetaGame walks you through some of the considerations, and DoughRoller gives you some additional factors to consider.

I did some quick back-of-the-napkin math, and in my case, replacing my Sallie Mae money market account with a HELOC is not a good idea. That’s simply because of where I find myself in the interest cycle.

I got my mortgage at 2.875%. Sallie Mae currently pays me 2%. My HELOC is considerably above that, in the 6-ish range. So, given an emergency fund of say $20k, I could save myself $175/year if I applied that to principal and relied on the HELOC for emergencies instead. It’s a relatively low amount because I got my mortgage when rates where near the bottom, and rates are now climbing up again.

In an emergency, I’d pay $625/year ((HELOC rate minus mortgage rate) times 20k) for dipping into the HELOC. Keeping in mind this may be higher: The HELOC uses a variable rate tied to prime. Now, hopefully, I wouldn’t need the emergency money for a full year. And, still, with the cost of using the HELOC, which is higher the higher the prime rate goes, the marginal utility of an extra $175/year, the fact that my money market account may eventually outperform my mortgage if prime keeps rising, and the fact that the HELOC might get closed on me in a downturn, I’ve decided I’m better off just leaving my emergency fund in a Money Market account. Sallie Mae pays amazingly good interest on those.

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