Should I Use a Line of Credit as an Emergency Fund?

When I went through and cancelled all of my magazine subscriptions, the only one that I kept was MoneySense magazine.

I’ve been reading MoneySense on and off for years now, ever since my mom would (strategically) leave it lying around the house in the hopes that I’d pick it up and learn something.

Her strategy worked, and I’ve learned a lot from MoneySense over the years.

In general, I think they give out great advice, from the Couch Potato Portfolio approach to their breakdowns of personal spending from real people in real situations. As a nosy personal finance blogger you know those are my favourite.

But when I was reading the last issue that hit my mailbox, there was one piece of advice that was like a needle dragging across a record (says the millennial who isn’t cool enough to have ever listened to a record.)

Cash out your emergency fund.

Excuse me?

MoneySense, purveyor of sense about money, is telling me to… get rid of my emergency fund?

Not exactly – but I still have a bone to pick with the advice.

As part of their #MoneyFit series, they quoted an advisor who said that by throwing your fully-funded emergency fund towards your mortgage, you’d save more in interest over the next ten years than your emergency fund would earn in a high-interest savings account. They use that to recommend that as long as you’re financially stable, a line of credit will be just fine as your emergency fund.

Now listen, I get where MoneySense was coming from with this from a math perspective. They and the advisor they quoted were relying on the time value of money calculations. Basically, they looked at what the cash in your emergency fund would be worth in 10 years in a bunch of different situations, and then recommended the one that would put you in the best financial position down the road.

And like any good mathematician, they stated their assumptions about the interest rates and the size of the mortgage in question.

But they forgot a few assumptions, too, that I want to make sure we’re all clear on.

Cashing in your emergency fund and relying on a line of credit is only a good idea if all of the following assumptions are also true.

You Have Savings for Your Next Car, Or a Major Breakdown*

*if you have a car

I was downtown the other day, and in true forgetful-Des fashion, was convinced I had parked on the lower level of the parking garage. Since I was so sure, I went straight to where I had parked my car.

And it wasn’t there.

Now, instead of being reasonable and checking the other level, I proceeded to walk back and forth along the five spaces where I was sure I had left my car, and worked myself up into a pretty good panic that oh my god my car was stolen. Just before I went full meltdown, I ran up to the first level of the parking garage.

There was Little Car, right where I had left her.

You know what was going through my mind during that entire experience?

“I really don’t want to pay for a new car.”

But also,

“Thank god I could pay for a new car.”

Right now, as I’m working towards hitting the goal I set for my emergency fund, I don’t have separate “car emergencies” fund. I don’t know many people who do, to be honest.

If you’re about to cash in your emergency savings and rely on a line of credit, you need to have a car emergency savings account that you don’t touch. Otherwise, that “emergency fund” line of credit? Yeah, it’s going to be what you turn to when inevitable car expenses or forgetting where you parked your car happens.

You Have Savings for Major House Repairs*

*if you have a house

Everything I said about cars goes double if you own a house, or are thinking of buying one – except for forgetting where you parked it, in most cases. Houses are crazy expensive, and that doesn’t just go for your mortgage payment.

What if a major appliance breaks? It’s your problem.

What if the pipes burst? It’s your problem.

What if the roof needs to be replaced? It’s your problem.

What if the garage door breaks? It’s your problem.

I think you get where I’m going with this. If you have a house, or are going to acquire one in the near future, you need to be saving for these and countless other routine expenses that can come up out of nowhere and destroy your carefully balanced monthly budget.

If that savings is separate from what you see as your emergency fund, great. But if those are expenses that you’d be pulling from your aforementioned emergency fund, let me be clear: a line of credit is not a suitable emergency fund for you.

You Have Savings for Life Events

Everyone has life events. Not everyone has a car, or a house, but everyone has life events.

Sister getting married in a far-flung location? Life event.

Having a baby? Life event.

Moving? Life event.

Getting married? Life event.

I’m not even saying you need a separate savings account to cover every single one of these potential possibilities, unless they’re imminent and decided upon already (if you’re planning a wedding, yes, you should probably save for it.)

But you should have enough of a cash buffer somewhere that if one of these things happened, it wouldn’t put you in a really tough place. For me, to be honest, that’s my “vacation and gifts” savings. I wouldn’t pull from my emergency fund if I went over budget on any of these life events, but you can bet I’d plan on spending less on vacations and gifts, and use that money to cover the shortfall.

If your emergency fund is that account for you – the one you’d turn to if you had to cover some unexpected life events – then a line of credit isn’t the best idea for your emergency fund.

Because life happens so much you guys.

You Could Meet All Your Monthly Obligations if You Missed A Paycheque

If I told you that you weren’t going to get paid this Friday, and you’d have to wait until mid-February to receive your next paycheque, would you panic?

How about if you didn’t have an emergency fund, and were relying on a line of credit to get you through?

I’m not going to stand here and say that I wouldn’t be relying, at least a little bit, on my emergency fund to get me through a missed paycheque. I totally would, because that’s why I have an emergency fund.

But if I had thrown my entire emergency fund towards my hypothetical mortgage? What would have been a minor inconvenience would now put me into debt on a line of credit. Debt that I’d be paying higher rates on than any mortgage out there.

If you have savings to get you through a regular month if something were to happen and your pay was delayed, fantastic. Otherwise, a line of credit is not a good emergency fund option for you.

You Have Bonkers Amounts of Stability In Your Line of Work

Have you ever been laid off? I have, and I’ve only been in the working world for a few years.

It was for business reasons, not performance, so I took it in stride and found a new job thanks to my freelancing connections. But as I was getting let go, I was able to remain calm and even make a probably-inappropriate joke about day drinking – because I knew my emergency fund had my back.

Having an emergency fund made getting fired way better in every way, because I knew I would be able to eat and pay rent even if I didn’t land a job the next day. My field – marketing – is fairly competitive, and I know plenty of people in my city who have gone months in between roles through no fault of their own.

In the MoneySense example we’re talking about, we’re looking at a ten year time period for those projected gains from cashing in your emergency fund.

If you can say to me with at least some degree of certainty that over the next 10 years, you don’t expect to be out of work for more than a month, go right ahead and cash in that emergency fund. You can probably rely on a line of credit, since job-loss emergencies aren’t something you’re worried about.

But if you’re like me – or in an economy that could suffer a recession like Calgary’s is right now – and you think it’s a genuine possibility that at some point in the next decade you may be in between jobs for more than a month or two? Keep your emergency fund.

Here’s an example, just to drive the point home.

If you’re out of work for four months, how much would it cost you to live for those four months? Maybe $2000 a month? If you’re using a line of credit when you get a new job, you’ve racked up $8000 worth of additional debt, that you now have to pay off, plus interest.

Sure, if you had taken $8000 out of your emergency fund, you’d likely want to save it back up. But you would have a sweet 0% interest rate on refilling those savings, and whatever high-interest savings rate you can get on top of that as it fills back up.

You – and Your Cashflow – Can Handle More Debt

I’ve never had any debt. Literally none.

Sometimes I think that because of that, I shouldn’t talk about debt at all, and for the most part, I don’t.

But here’s what I can say about it.

At the end of the day, you might not have any of these assumptions checked off, but you might be incredibly comfortable with debt. You might know you can handle it, and be willing to take the risk and get the payoff of cashing in your emergency fund to either pay down your mortgage, or invest, or some other option I haven’t touched on yet.

If that’s you, and if your monthly budget could accommodate a potential new debt repayment, maybe a line of credit is a good emergency fund option for you. If you wouldn’t panic or break your budget if an emergency did happen and left you with a balance on your line of credit? Go for it.

I’m not that person.

I’m the person who paid for her car in cash, and the one who would rather not add a sizeable debt repayment to my monthly budget if I can help it – partially because it would cut into my cashflow and make achieving my other goals much harder.

That said, you’re not me. It’s the great thing about personal finance – it’s personal. So if you know that adding a new debt payment after an emergency would be no sweat, either for you or your budget? Maybe a line of credit is the right emergency fund solution for you after all. If that’s you, awesome – and your time-value-of-money calculations will be able to put that emergency fund cash to great use.

On the other hand, if that’s not you – or if any of these additional assumptions raised red flags?

Don’t cash in your emergency fund this year.

Do not pass go, do not rely on a line of credit in case of emergencies.

Because a line of credit is still not an emergency fund – at least not for you, and definitely not for me. I hit almost none of these additional assumptions, haha.

What do you think – would you be comfortable using a line of credit to cover emergency expenses like a job loss or a major house repair? Or would you rather have the money in the bank and accept a lower and safer interest rate? I’d love to hear your thoughts – I know this is a heavily debatable topic!

PS. This entire example is based on what to do if you already have a fully-funded emergency fund – so if you, like me, are still working on saving it up, make sure to run the numbers and balance your emergency fund goals with your other priorities. I’m just saying.