I just feel better when everything is well stocked. I am made strangely happy at the sight of a full fridge. My pantry is always provisioned and emergency water never goes low. This emotional response extends to my short-term finances. Having an adequate emergency fund AND access to a dependable line of credit helps me sleep. (Also see: You Need an Emergency Plan, Not an Emergency Fund)
For myself and for many of my clients, I recommend obtaining the largest home equity line of credit (HELOC) for which you can get approved, and then DON’T USE IT. A HELOC, used in this way, is a powerful extension of your emergency reserves that costs little or nothing and may provide extra peace of mind.
If you are a spender who feels excited at the idea of new cash being available and don’t have a spouse or advisor that will call you on overspending, stop reading this post. Seriously! Beat it. A HELOC is like a credit card, but one that you should leave unused in a drawer. (Forgive me for the use of some financial jargon in the coming paragraphs.)
A HELOC is backed by the equity in your house, thus the low interest rate. With the run up in real estate values, the available line of credit can be substantial. Let’s say your home would appraise for $2 million and that you have a mortgage with a $1 million balance. You may be able to obtain a HELOC of as much as $600,000.
As a line of credit, as opposed to a loan, you don’t have to receive funds unless you choose to. If you don’t draw any of the available funds, it costs you nothing in interest. You may have to pay a small loan origination or annual maintenance fee, but often not.
A HELOC is not a replacement for an emergency fund.
HELOCs can be frozen in a financial crisis. You may recall that in the Great Recession banks reduced or even froze the ability for homeowners to use their HELOCs. That was an exceptional recession. We have had and will have many recessions of lesser magnitude. But for 2008, 1972-3, and 1929 type events, this could fail.
Everyone should have liquid savings to cover at least three months of expenses. Liquid savings might be a savings account, a CD, a money market. It will be invested in something that will not lose value and which you can get to immediately. For high level executives for whom job searches can take longer, I often advise setting aside enough to cover expenses for a full year.
It can take time to get to that level of emergency savings. And it may not make sense to, for example, forgo tax deferred savings into a retirement account to get to that level of emergency reserves quickly. In this case, a HELOC can temporarily bridge the gap. Even when you do reach your target emergency fund, the HELOC just makes your personal financial moat wider and deeper.
Spender! Yeah you. I had a feeling you would keep reading. Know that if you use your HELOC to finance spending that you could not otherwise afford, this is a dangerous tool. The rate isn’t fixed. Debt service can explode. Interest rates dragged rock bottom from 2009 to 2015. The Prime Rate[1], to which HELOC interest rates are often pegged, has since risen from 3.25% to 4.5% and futures markets have priced in a further increase to 5.25% by the end of 2018. Historically, the Prime Rate has been closer to 7.7% on average and has been as high as 20%. Boom! That would be a 4X+ increase in interest expense.
Worse, under the new tax law, the interest on your Home Equity Line of Credit is no longer a tax deduction. That raises the cost of borrowing too.
Use your HELOC as an emergency back stop only.
Talk to your advisor and then, if she agrees, do this now. Don’t wait until you need it. Maybe you will lose your job, or there could be a recession. Whatever the reason is that you would need this might also be the reason you can’t get one. It is a lot like insurance that way.
You might not believe this, but I am an optimistic guy. I am not fretting about a recession or a bear market any more than I would about an earthquake. And I DEEPLY believe in equities for the long term. I just want to make sure I always have a path over the short term.
Sleep tight!
I will leave a discussion of margin borrowing against your portfolio (the next backstop) for another day.
[1] https://fred.stlouisfed.org/graph/?id=MPRIME
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