Using a Home Equity Loan for an Emergency Fund

Most mainstream financial advisors will suggest that you should keep some money aside in a special savings account for emergencies. This seems to make sense, say if there's something such as a car accident, an unexpected medical expense, or something goes wrong in the house, there's money to take care of whatever needs to be paid for. This way when an emergency does happen, you don't have to freak out and wonder where the money comes from.

It certainly makes sense to keep some money in cash reserves so that you have money that you can get to on a short notice should you need to, but doing this comes at a price. This is essentially self insuring your self for emergencies. Like all insurance policies, they come with a cost. Putting money away in a savings account for no other purpose than paying for emergencies might not have a visible cost, but you do have to put it in a rather conservative investment so that you can be sure the money is there when you need it. You don't want to have your emergency fund in mutual funds only for you to have an emergency when the stock market happens to be down! Generally people will put their emergency funds in basic savings account earning 4% or 5% interest.

A lot of people who consider themselves financially savvy think that putting money away in a basic savings account has too much of an opportunity cost for that to make financial sense. They would rather invest that money in something that will have a bit more risk but come with a much better rate of return over a long period of time. Of course they still need some cash available should an emergency happen, so many people get what are called a home equity lines of credit.

Essentially a home equity loan or a home equity line of credit is a revolving loan similar to a credit card. The difference is that your home equity line of credit is a secured loan, it's a second mortgage. This is why you can get much better interest rates on home equity loans compared to credit cards. If the borrower happens to not pay, the bank can foreclose on the person's home and recoup their cost.