I Think This is BAD Money Advice
February 25th, 2008 by Ana
I usually don’t go this far out on a limb and straight up call someone’s opinion about money wrong … but this advice sounds downright financially dangerous to me! I will state off the bat I don’t know this blogger from Adam and found the post while browsing the popular list over at pfblogs.org. Here’s my beef: Personal Finance Guide (dot org) not only recommends using a HELoC as an emergency fund, but claims having a CASH emergency fund is costing “more than you think” and goes on to extoll the virtues of digging yourself deeply into debt when an emergency happens. (Interestingly enough, a year and a half ago, this same blogger thought emergency funds were a GOOD idea.)
GASP! CHOKE! SPUTTER! This blogger even says to use a HELoC to buy groceries when money is tight! What is wrong with this picture?? Buy groceries and pay for them for the next several years??? Of all the “debt-is-good” planets people can live on, this one has to be the most hostile to personal financial wealth!
The really bad part is this blogger is not alone with this idea of using a HELoC instead of a cash emergency fund. Some bloggers are not as specific about using credit instead of an emergency fund, but the idea remains. There are MANY more examples, but these were mentioned when I brought the subject up on a blogger board I frequent.
I have said it before, I don’t think HELoCs are good for much at all. Not to “pay down” credit card debt (note the quotation marks!), and definitely not for an emergency fund. What if the emergency is a job layoff? Or a double job layoff (both you AND your spouse)? How about some idiot running a red light drunk and T-boning you, resulting in a prolonged hospital stay and time out of work? How about an injury that results in permanent disability? Even worse yet, how about a death in the family? All of these things happen to people every day in America! Are any of these situations an example of when you want to go into MORE debt?
Or here’s another real-life example this blogger obviously didn’t consider: what if you live in an economically depressed area … like maybe Michigan? What if you live in the “foreclosure capital of the USA” as Detroit, Michigan (replacing Stockton, California) has been declared lately? Or any other region where home values are plummenting as the housing market bubbles burst? All of a sudden, you might not HAVE equity in your home anymore! If that happens, using this blogger’s advice …POOF! You don’t have an “emergency fund” anymore. Even worse yet: what if you find yourself upside-down in your mortgage because home values declined?
Yes, I know cash actually does go down in value. It’s what we commonly call inflation. But I don’t think inflation is nearly as high as some of the declines in housing values going on right now. Plus cash doesn’t put you in debt. The last thing I would want in an emergency would be more bills that need to be paid … and a HELoC puts your home up as collateral. So if the emergency is prolonged and you use a HELoC, not only do you have another bill, but if you can’t pay that bill you are in danger of losing your home. NOT a good plan!
I will personally stick with my plan of a cash emergency fund. I personally advocate others do the same. It just isn’t worth the risk!
Posted in mortgages |
February 26th, 2008 at 5:36 am
Yes, well, as with all things… it depends.
I have the equivalent of a HELOC loan (called a ‘Portfolio loan’ from our home and investment mortgage bank). It’s mainly used to pay for investments (the interest rate is lower than margin loans or other sources of money) and the investments have a long-term historical average return higher than the interest rate. Also, the interest is tax deductible, whereas the long-term capital gains (hopefully) made when the investments are eventually sold are at half my marginal income tax rate. So, even if the total return of the investments (capital gain + dividends) only matches the interest paid on the loan, I still end up ahead by reducing my income tax.
I have some unused credit limit on the HELOC, so for any emergency I could just draw-down and transfer the funds to my credit union account, where it is available via debit card, cheque or cash (ATM) for immediate use. I can then either choose to pay the interest on the borrowed amount while I pay it off from my cashflow, or pay it off immediately by liquidating some investment or other. I could get the funds directly by liquidating an investment, but there is a couple of days settlement period before funds become available when you sell stocks, and there may be capital gains issues that would interfere with your tax plan for the current financial year.
I sometimes do have a small amount of cash sitting in a high-interest online savings account, for example I’m currently saving up some cash for a holiday in August. I could use the cash to temporarily reduce the balance of one of my investment loans, but the interest rate differential isn’t high enough to make it worthwhile for a short period, and there are potential tax issues if you pay off a loan that was taken out to fund an investment, but the redraw the same amount later on for a non-investment purpose such as a holiday.
I’m not concerned about the major emergencies you mentioned (TPD, temporary illness) preventing me servicing the loans as I have sufficient income protection insurance in place to mitigate such risks.
Of course, the situation would be completely different for someone with minimal net worth (probably tied up in their home equity), and that had insufficient insurance in place to handle major interruptions to wage income.
As I said, whether or not using a HELOC instead of a savings account as the planned source of emergency funds is a good idea all depends on an individual’s particular situation.
February 26th, 2008 at 7:48 am
People think they can get HELOCs based on the home equity–partly true. But you actually get and keep a HELOC based on your ability to repay–your income! If the bank hears you’ve lost your job, poof, there goes your so-called emergency fund. Frozen. Closed. Gone. Then you don’t have a cash fund either. Then you’re calling Dave Ramsey confessing your stupid tax and begging for advice. LOL
February 26th, 2008 at 7:51 am
EnoughWealth - I wouldn’t use your HELOC like that unless it has sub-accounts so you can keep the deductible debt separate from the non-deductible debt.
If you commingle the two different types of debt and make any payments to the principle then the tax authority (CRA in my case) can argue that the principle payment went towards the deductible debt instead of the non-deductible debt.
Best thing is to keep them separate.
Mike
March 1st, 2008 at 1:22 pm
Cash is king. I don’t like financing anything. When you borrow, there is always going to be a payment to make in 30 days.
March 19th, 2008 at 2:59 pm
If you have a cash emergency and your choices are to take money from your HELOC or take a cash advance from your credit card, then the HELOC is probably the better choice as the interest rate is far much lower.
David
March 20th, 2008 at 1:50 pm
Agreed - that is HORRIBLE advice and I hope no one is mislead. It’s sad how anyone with a blog is seen somehow as an authority.
My only thought is that the author might have a confused understanding of the Money Merge Account (MMA) which works in conjunction with a HELOC to pay down your first mortgage. Some people direct some of their savings (not their entire emergency fund) to this to help pay down their first mortgage, but the MMA program does not discourage people from using sound financial planning principals as it is simply another tool for one’s financial planning arsenal (and a very good one at that).