One thing I always hear veteran homeowners say to new home buyers is to open a HELOC as an emergency fund.
That way if anything comes up, you’ve got a lifeline to pay for mandatory expenses, whether it’s the power bill or groceries.
The general idea is you get a credit line but you don’t actually need to borrow from it.
This differs from other loans, including home equity loans, in which you actually receive the funds at closing.
So is it a good idea? Well, it depends, and there are several drawbacks I can think of immediately.
HELOC May Have a Minimum Draw
The first issue is your home equity line of credit (HELOC) may have a minimum draw amount.
For example, you might be told you’re approved for a credit limit of $50,000 and that you actually need to draw 85% of it.
This was in the fine print on Chase’s HELOC, which I took a hard look at last year when it was relaunched.
That would mean at least $42,500 would need to be taken out at closing. You couldn’t just open the line and leave it untouched and wait for an emergency to pop up.
Of course, you could also pay it back promptly and avoid most of the daily interest.
So you wouldn’t necessarily be charged all that much. But to avoid this, compare different HELOC lenders and find one that doesn’t require a minimum draw.
This could save you some money and legwork in the process.
I’ve found that credit unions are the most flexible when it comes to this, while other lenders might require you to draw the entire line!
Be sure to find out these key details before you proceed.
HELOC May Have an Origination Fee
Along these same lines, a lot of banks charge an origination fee for opening a HELOC.
Using our same example, you might be charged 2% on the total credit limit at closing.
In other words, if it’s $50,000 and you don’t necessarily need it today (or tomorrow), you’ll still be charged $1,000 at closing.
So your so-called “emergency fund” just set you back $1,000, plus any other applicable closing costs.
Not off to a great start for something you don’t even plan to use!
Even worse, it could be even higher than 2%, perhaps up to 5% of the credit line. So watch out!
Again, find a bank or credit union that does NOT charge an origination fee on HELOCs and you can avoid this issue.
There are definitely companies out there that don’t charge these fees. You just need to put in some time shopping lenders.
HELOC Draw Period Might Only Last a Few Years
Yet another issue with using a HELOC as an emergency fund is the fact that the draw period, where you can actually tap it, might be limited to a few years only.
For example, Chase’s HELOC only has a three-year draw period, despite being a 30-year loan.
Put another way, you can only use it as an emergency line for 36 months. After that, your line is essentially shut off.
And you’ll simply have the opportunity to pay it back, whether it’s interest-only payments or fully-amortized payments.
Again, shop around with different HELOC providers to see who offers a longer draw period.
You might be able to find a lender willing to give you a 10-year draw period, which is a lot more beneficial if cash needs pop up unexpectedly.
The last thing you’ll want to do is open a HELOC only to find out it can’t be drawn upon a few short years later.
If you do find one with say a 5- or 10-year draw and it’s coming to a close, consider refinancing the HELOC to get a fresh draw period.
Your HELOC Line Could Be Frozen
The last potential pitfall to using a HELOC as an emergency line is the fact it could be frozen if you fact find yourself in an “emergency.”
For example, if you lose your job and/or miss payments on other liabilities and your HELOC lender finds out, they might freeze your line.
Now the credit line you were relying upon to get you through said crisis has absolutely no practical value.
The same can even happen if home prices happen to plummet. It’s something we saw during the early 2000s housing crisis.
Banks simply shut off the spigot and all those homeowners with HELOCs they thought they could use were simply out of luck.
So while a HELOC can potentially be used as a lifeline in some situations, know that it’s far from foolproof.
There are lots of potential gotchas and potential costs that could make it unattractive, as outlined above.
But if you shop around and find a HELOC with good terms, such as no origination fees, no minimum draw, and a long draw period, it could act as a good safety net.
Read on: Top HELOC Lenders in the Nation
Before creating this site, I worked as an account executive for a wholesale mortgage lender in Los Angeles. My hands-on experience in the early 2000s inspired me to begin writing about mortgages 19 years ago to help prospective (and existing) home buyers better navigate the home loan process. Follow me on X for hot takes.