Why a line of credit is not an emergency fund - Give Me Back My Five Bucks

Why a line of credit is not an emergency fund

For years, my line of credit was my crutch. I used every available dollar of credit available to help me limp from month to month, or whenever an “emergency” arose.

Times have certainly changed for me. I just hit the $10,000 mark for my emergency fund – which represents 4 months of comfortable living based on my current needs – or 5 months of living on a bare-bones budget. However, now that I’ve been debt free for a few years, I’m often asked why I don’t use a line of credit as my emergency fund instead – leaving me with the entire $10,000 – which I could invest in something that might earn me more than the 1.50% interest that I’m getting right now.

Some personal finance bloggers believe that a line of credit is the perfect solution to a true emergency. But I’m not one of them. I’m a full believer in having a cushion made of cash, not credit. :)

Here are 5 reasons why I will never use a line of credit for an emergency fund again:

  1. Savings means having breathing room: Having a cushion allows you the freedom to work through your emergency without having to go into debt at the same time. While it’s true that the money in your emergency fund will eventually run out, the same can be said about a line of credit. The difference is, after your emergency money is gone, you will still be debt-free. And should you need to look into other options for a long-term emergency situation, you will be that much farther ahead.
  2. Credit lines aren’t savings: The most obvious problem with using a line of credit as an emergency fund is that you eventually have to pay it back. If you are forced to use your emergency fund, then you are clearly in an ‘emergency’ type of situation. Why would you want to face the added stress of piling on debt? If you’ve ever had to use your credit card before to make an unexpected purchase, then you’ve probably experienced the stress involved with trying to figure out how you’re going to pay it off.  The same can be said with a line of credit. Don’t think the lower interest rate will be easier to handle than that of a credit card! Debt is debt, and it is stressful no matter how much it ends up costing you.
  3. The bank controls your credit line: A huge obstacle with using a line of credit is that you are at the mercy of the bank, as well as fluctuating interest rates, and changes to policies and procedures. If your line of credit is secured by your home equity, you have the added pressure of knowing that you will be putting your house is at risk.
  4. Credit doesn’t offer security: An emergency fund is meant to act as a cushion. If you stumble, it is there to catch you, no strings attached. You don’t have to worry about payment schedules, interest rates, or mounting debt. Relying solely on credit means that you are always living on the edge. Having cash in the bank gives you options. You call all of the shots. Not only will your own money give you a solid sense of financial security, but there is something to be said about the confidence it will give you as well. Knowing that you can handle virtually any situation that comes your way is an empowering feeling.
  5. Nobody is immune to emergencies: Remember that no matter how stable your job might seem, or how good your health is, nobody is immune to emergencies. And sometimes, you just don’t know how long you will be stuck in that kind of stressful situation.

Being faced with an emergency is the absolute worst time to go into debt. Protecting yourself from life’s inevitable obstacles is a huge part of creating financial security. Having an emergency fund will open up doors for you during a period in your life where you will need all the help you can get.

Would you use a line of credit as an emergency fund?

About Krystal Yee

I'm a writer, personal finance blogger, and marketing professional based in Vancouver. I'm a former Toronto Star (Moneyville) columnist, author of The Beginner's Guide to Saving and Investing, and co-founder of the Canadian Personal Finance Conference. When I'm not working, you can usually find me running, playing field hockey, or plotting my next adventure.

29 comments

  1. My favourite point that you made is that if you have to use an emergency fund, you’re clearly in an emergency situation. The idea of also being stressed about mounting debt while in that situation is terrible to me. The last thing I’d need is the stress of mounting debt and the idea of how exactly I’m going to pay that back. Great post.

  2. I agree. I built up a $5,000 emergency fund, which I recently (as in, last Wednesday) had to use the bulk of. If I had it on a line of credit, it would have increased my stress ten fold.

  3. I agree 100% with this post. Why would anyone consider a LOC an emergency fund? It’s bad enough to be have little to no income without having to watch the debt to equity ration climb every week/month. Where 1.5% isn’t a great ROR and currently doesn’t even cover inflation, especially after having to pay tax on $150 interest, it is a 100% better then being $1 – $10000 in debt and paying 3% or up to $300 in after tax dollars in interest on the borrowed funds.

    Those who want to consider LOC of as a form of emergency fund would just have $20000 in their emergency fund $10k in cash and $10k in credit obviously spending the $10k in cash first as needed.

  4. I’ve never used a line of credit, and I wouldn’t use one as an emergency fund, either. How long does it take to get access to the money? Can you just walk into the bank and withdraw funds on the same day?

    Either way, going into debt in an emergency situation just seems like it would add to the stress, too.

    • @Jeffrey: I used to have a $35k line of credit. I used it for “emergencies”. When Bank of America wanted $350 a year to use the line of credit, I cancelled it. They were more than happy to cancel it. I’ve had a few situations where I wanted to use it, but I know just have a reserve in my checking so I can avoid this situation.

      Just because you think its an emergency does not make it so. Sometimes it is just a lack of planning.

  5. I completely agree! Using a line of credit for an emergency is very unwise. What if your emergency is a job loss, how would you pay back the line of credit with no savings.

    You could save the equivalent of a line of credit and be in a much better situation.

  6. I agree with your post completely. I would never use a line of credit as an EF, because you would eventually have to pay it back (plus more).

  7. “Relying solely on credit means that you are always living on the edge.” What a great statement, you captured the peril of credit debt in one sentence! I think you are correct that it is better to have money saved in an emergency fund then counting on a line of credit or a credit card if the unexpected happens. Not to mention, if you had trouble paying back the line of credit or made late payments, it could damage your credit score.

  8. I too used to be like that and then I asked myself the question, why should I pay banks any money, they are filthy rich, why should I contribute in making them richer and myself poorer, so I decided 3-4 months ago to start building up an emergency fund and I don’t regret it one bit. The worst part is that my financial adviser (from my bank) told me I should use the Credit Line for Emergency fund…I pretended I agreed with him because I didn’t feel like discussing this with him, because I am sure he is forced to tell me that because he works for the bank, nonetheless I didn’t listen to him.

  9. I use a LOC for an emergency fund simply because I don’t want to have $xx,xxx sitting around in an account not doing anything for me. If I have extra cash lying around it goes right into either my RSP, TFSA, or some type of trading account/investment where it compounds a lot faster than it would in a typical savings account.

    I can’t see myself having any type of emergency costing over $10,000…I’ve yet to wake up and say, “The world is ending, I need to buy a new Porsche right now so i need $10k for a down payment”, or “Someone was hurt travelling in Australia so I have to fly out there and see them….and might as well stay at a 5 star resort…for a week…”

    Hypothetically, if I had to borrow say $10,000 at an astronomical rate of 7% (even though LOCs have rates ranging from 3% to 7% on average from the ones I’ve seen), thats $700 in interest if I don’t pay it back for a full year, which isn’t likely, but also isn’t the end of the world in the grand scheme of things should an actual emergency come up. If this were the case, I’d also be able to use cash from TFSAs, investments, etc. to pay it off right away, although it would take a couple of business days to transfer the money out and I would lose out on potential returns.

    In summary, I don’t use an emergency fund because of the oppurtunity cost having money “sit” there.

  10. I completely agree. If we didn’t have an emergency fund in place right now, we’d be in debt immediately. That’s what I see a LOC as. We could borrow from our life insurance plan at 5% – I don’t want to borrow money when I’m already strapped for it! I thought that $25K would be enough for an emergency fund – I forgot about health insurance! We have decided that if all else fails – we run through our savings, cash out stocks and run through those, we will take out a LOC – but that’s a last resort, not an emergency fund.

  11. I keep 6 months of job loss emergency reserves in addition to each of my insurance (auto, health, renter’s) deductibles in reserve.

    If I kept my reserves entirely with an online bank instead of keeping all of my reserves at my credit union where I can do instant online transfers to my checking account, a line of credit could be useful until the funds could be transferred from the online bank.

    I am completely with you that savings provide breathing room. I very infrequently stress about money since I have such great reserves for when something bad happens and I can also dip into monthly cashflow if there is a problem.

  12. I’m with you. Credit is credit. Savings is savings. And that’s the end of that.

  13. Cait said it well.

    While a LOC works for many as an emergency fund, in an emergency, the last thing I want to worry about is borrowing money.

    Your post has kicked me in the pants to get the EF higher to our goal of $10 K.

    Good post.

  14. Um…NO!!! That is just going into debt. It does not make sense to me to use a line of credit for emergencies. It is better to have a cash cushion.

  15. So if no one uses a LOC for emergencies, is it safe to assume that no one has one? If people do have them, what would you use them for, if not for emergencies?

    Given the amount of comments along the lines of “no debt” and “boo interest” I’m a bit lost given Canadian LOC applications and new accounts have been on the rise lately.

    If you do have a LOC and also are building an EF, why would you not use your EF cash to pay off your LOC first and eliminate all those monthly interest payments, lower your credit utilization, improve your credit score, etc?

    • I’m a believer of having an EF separate from any debt that you might owe. Even a LOC. Just like people who have credit card debt at a much higher interest rate than a LOC, should also have an EF. If you put all your money towards your debt without building up a tiny cushion to fall back on, you’ll just end up relying on credit all over again.

      I have a LOC without a balance right now, and I would probably use it as a back-up to my $10k EF if the situation ever came up and I was desperate.

  16. “If your line of credit is secured by your home equity, you have the added pressure of knowing that you will be putting your house is at risk.”

    What do you mean by this?

    • Potato,

      When you use a home equity line of credit the collateral on that debt is your home. This means that if you miss payments, or default, it is the same as doing so on your first mortgage.

      Many people feel that using your home as collateral on anything other than the home itself (meaning something that either maintains or improves the value of the home) is a big no-no.

      I’m typically within that same school of thought–nothing ever goes on my HELOC unless it’s something that is for the home (like a new roof, etc).

      The slippery slope with a HELOC is the temptation to mis-use it. Let’s say I put a roof replacement, $8000, on there… well that is “OK” because it’s for the house… but is it still OK if I had spent $8000 on new furniture, a TV, stereo, and a vacation? Yes the $8000 on the HELOC is for the house, but it would be bad to use it as a crutch to allow you to spend recklessly in other areas.

      Just to comment on the original article, it’s nice, but it’s a big long winded to make two basic points:

      1) A LOC is extended to you and may be retracted at any moment. You can’t rely on it being there.

      2) Borrowing for emergencies is usually bad…. though this is a gray area and depends on your definition of “emergency”. If the emergency is your loss of income then I 100% agree that borrowing to make ends meet is a HUGE mistake… if the emergency is needing cash quickly, then I think a LOC can be an acceptable place to turn.

  17. I absolutely wouldn’t use a line of credit as an emergency fund. Ever. That said, I DO have a line of credit that I intend to use as a sort of safety net/stop gap for cashflow issues now that I’m working full-time freelance. The point of it isn’t so much to dip into it if I have a lean month (I have savings for that), but moreso to float me if I need cash, and a paycheque hasn’t come in yet. So basically, my rule of thumb is that I can only take out as much from my LOC as I have already invoiced. So far I haven’t had to use it.

  18. I’m a little late on this, but whatevs. Better late than never and whatnot.

    I’m quite okay with people using a credit card for their emergency fund. Wha!?!?! Am I crazy?

    Here’s the kicker. Everybody should have a portion of their investment portfolio in low risk fixed income products – either a bond fund or GIC. So instead of somebody having an emergency fund and a fixed income portion of their portfolio, they should just combine the two. Then, if an emergency happens, you can just charge up the credit card while you take your time selling the investment. If you’re buying short term bonds (less than 2 years to maturity) you don’t have to worry too much about price fluctuations. Or sell the GIC and forego a bit of interest.

  19. The difference is, after your emergency money is gone, you will still be debt-free.

    You’ll hardly be “debt-free”, since you’ll have to pay back into your emergency fund. You’ll simply have incurred a debt you owe to yourself. Aside from the flexible repayment terms, it’s hard to see how that’s much better.

  20. I have only borrowed from a cash advance place once, but have used the emergency overdraft convenience choice through my bank’s atm, accepting the $35 fee with great chagrin.
    What does one do when you have no savings, no funds in hand yet an emergency arises?
    How do you take care of things when there is no way to get financial assistance unless through a quick loan business?
    If you need $20o yet have 40 cents to your name, what other solution is out there?
    I don’t plan on taking out another cash advance loan, but I have not found any other options available.
    I know the first step is to start saving, but sometimes it is impossible to save when every penny you get is already assigned to monthly bills and other neccessities…
    Stuck in a rut of cycling yet not able to get ahead.

  21. Hmmmm lets look at an example, to see if a LOC is really all that bad.

    Jose and Maria have 3 kids aged 12-16 and strongly believe in living within their means and saving as much of their income as they can. They saved rigorously for the past 10 years and recently acquired a house for $450,000, 80% of which is financed through a 3.5% mortgage. Their after tax household income is about $85,000 and after accounting for the family’s living expenses, they have about $10,000 left over for discretionary consumption. They decide to put 50% ($5,000) of this in an emergency fund, which is held in a savings account earning 1%. They invest $2,000 in the stock market on which they earn about 8% per year and the rest of their money is spent on a vacation. They are also approved for a $20,000 line of credit but they don’t use it because they don’t want to pay the 4% interest expense.

    Status Quo:
    Interest expense for the year for mortgage $12,400
    Earnings in savings account ($5,000 * 1%) $ 50
    Earnings from investments ($2,000 * 8%) $ 160
    Cash outflow $12,190

    Invest in the stock market:
    -Borrow from line of credit (assume emergency money needed)

    Interest expense for the year for mortgage $12,400
    Line of Credit charge ($5,000 * 4%) $ 200
    Earnings from investments ($7,000 * 8%) $ 560
    Cash outflow $12,040

    -Emergency money NOT needed

    Interest expense for the year for mortgage $12,400
    Line of Credit charge ($5,000 * 0%) $ 0
    Earnings from investments ($7,000 * 8%) $ 560
    Cash outflow $11,840

    This may be a simplified example, but it shows that in a case where your emergency does not arise, the opportunity cost of holding onto cash just makes no sense. Even if your emergency arises, the net cash outflow is still higher than holding on to cash. You might as well put your money to work and let it earn some sort of return. The scenario used the stock market ( which has returned roughly 8% on average over the past 50+ years), but if you aren’t comfortable with the stock market as long as returns are higher than the cost of the mortgage debt you’ll be fine. What people don’t understand is having the LOC costs you nothing until its actually used, till then you might as well consider the time value of money and not let inflation erode your cash.

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