NEW YORK (CNN/Money) -
Is it a good idea to keep a home equity line of credit as an emergency fund?
-- Terri, Burbank, Calif.
Yes, I think it's a great idea to have a home equity line of credit as an emergency fund. With the economy so unstable, you never know when some financial problem may find its way to your door -- a pink slip from an employer who has "right-sized" you out of your job, unexpected medical expenses, college tuition bills. Being able to write a check against the equity in your home provides a quick and convenient way for you to meet unexpected obligations.
Of course, they don't let you borrow against these lines for free, although the interest rates these days on home equity lines are attractively low. Most lenders charge about a percentage point above the prime rate (currently 4.75 percent), and you can often find lines that let you borrow below the prime rate.
What's more, repayment terms are pretty flexible. You usually pay interest only for the first ten years and then begin repaying the loan over a term of 10 years or more. That's more than enough time to allow you to regain your financial footing after going through a rough time. To find lenders offering low rate lines, check out our RateSearch section.
But it shouldn't be your only basket of eggs
But while I think it's okay for a home equity line to be "an" emergency fund, I don't think it's a good idea for a home equity line of credit to be your only emergency fund. Which is to say, I think your first line of defense in emergencies should be savings -- specifically, three to six months' or so worth of living expenses tucked away in a type of account that isn't subject to big downdrafts, such as a money-market fund, a short-term CD (less than one-year maturity), a savings account or a combination of several of these.
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True, these accounts typically pay a paltry 1 to 2 percent interest these days, but by doing a little comparison shopping you can at least find the highest of the low rates. Again, the place to start your search is our RateSearch section.
One final note: By making borrowing so easy, home equity lines induce some people into frittering away their home equity on "necessities" like lavish vacations, flashy new cars and the like. I'm sure you don't fall into this group. I'm sure you'll use your back-up home equity line responsibly. But I mention this just in case there are any of those profligate types out there who will take any chance they can to live beyond their means.
Walter Updegrave is the author of Investing for the Financially Challenged and can be seen regularly Monday mornings at 8:40 am on CNNfn.
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