Question: Are you an advocate of building an emergency fund while you pay off debts or do you recommend paying off debts first before you start building an emergency fund?
The debt referred in the question does not include mortgages but does include student loan, credit card loan, auto loan, and home equity loans. I’m sure there are other types of debts out there but these four are the major ones I could think of.
After I paid off my auto loans several years ago, I opened an ING Direct account to start an emergency fund, which I contributed every month. I had accumulated little more than $13,000. My intention for this emergency fund was to cover all the bills in an emergency situation such as if I were to unexpectedly lose my job or if I needed money to cover any high expense health related expenses. My intention was not to use for any unexpected expenses such as fixing a car or home repair or any unexpected high bills because my goal was leave my emergency fund alone as long as possible without draining it.
The only debt I have, besides my mortgage, is the home equity line of credit (HELOC) loan as I already paid off my auto loans and I always pay off all my credit card payments every month. My goal was to pay off remaining HELOC loan as soon as possible so I had been thinking about using my emergency fund to partially pay it off. After going back and forth about whether to use the emergency fund, I finally decided to do it and made a big payment last month. The reason is simple. It’s the immediate money saving that made me make this transaction. My emergency fund was getting about 0.5% in my ING Direct account while I was paying 2.75% on the HELOC loan. Unfortunately this left me with no emergency fund. In fact I will not be able to start building another emergency fund until all the HELOC loan is paid off, which leaves me at a vulnerable situation. Did I make the right decision here?
To mitigate this risk of not having an emergency fund available when I need it, I started to think of my options and was able to come up with 5 decent options.
I like to be self sufficient and don’t want to rely on my parents especially when it deals with money. However, if I was to be in a situation where I needed their help, I am willing to ask my parents for their financial support and I’m sure they are willing to help, right? To make this a feasible option for me and my family, I can start talking to my parents now about my plan to use them as financial risk mitigation plan and receive their agreement.
Borrow From Home Equity Line of Credit (HELOC)
Since I already have a HELOC opened, I can always rely on it to borrow money when needed. It gives me financial flexibility by having this HELOC available. It might be a good idea for those who already own a house to open a HELOC in case of an emergency. But be aware that the interest rate could go up in next several years. Therefore, you do not want to accumulate too much debt with HELOC. Also, by opening a HELOC, you are essentially using your house as collateral. Therefore, it can be risky and I do not recommend this to just anyone. Nonetheless, I can always depend on my HELOC in emergency situations and no credit check is required once you have approved HELOC.
Whole Life Provides Cash Value
I am fortunate that I have started a whole life insurance when I was in my twenties. After 9 years, I have accumulated cash value of more than $9000 and it now gives me an extra financial flexibility by giving me the option to borrow from this $9000 if I ever need some extra cash or just taking the cash after cancelling the whole life insurance (which by the way, I will not be doing). Borrowing from your whole life insurance does not require credit check.
401K To the Rescue
Having the flexibility to borrow against your 401K plan is good news especially to those who need quick access to cash without going through a credit check. However, be very careful when you consider borrowing from your 401K and definitely understand all the disadvantages associated with it. I would use 401K as my absolute last option.
Benefit of 0% APR Credit Card
I understand why people do not recommend borrowing from your credit card but I do not want to underestimate this option when I need some extra cash in emergency situation. For me, borrowing from a credit card that provides 0% APR is a great option since I already do not have other credit card debt. However, I would have to find and apply to a credit card that provides this promotion.
As you can see, I have several options for me to reach out financially in emergency situations despite not having an emergency fund available in my back pocket. Obviously, my primary option would be to tap into my HELOC again if I were to be in an emergency situation where I needed extra cash. Because of this option, I decided to use my emergency fund to pay off my HELOC debt to save almost $300 per year or 2.25% in interest. Would you have done the same thing or did I make a mistake getting rid of my emergency fund?