When it comes to emergency funds, how much should you save? Depending on who you talk to, different people have different philosophies. Some will say three months of expense is sufficient, some will say six months, while other more conservative minded will recommend twelve months. Regardless of the amount, there is no right or wrong answers. The bottom line is, when an emergency hits, the most important thing is having access to and enough funds to cover the emergency at hand, not value of your emergency fund account. Below are the five methods that I use to assure that I have quick access to funds on short notice when an emergency hits.
Home Equity Line Of Credit (HELOC)
This is a line of credit that is secured against your home provided that you have at least 20% of equity in your home. This line of credit grows as you pay down the principle of your mortgage. You can have access of up to 65% of the value of your property if you pay off your mortgage. This form of borrowing is usually the cheapest as the interest rate is very close to prime rate (the interest rate that financial institutions offer their best customers).
Unsecured Line Of Credit
This line of credit is not secured to any assets that you own. However, if you have more assets, it’ll give you access to a larger borrowing limit. The available limit of the line of credit is determined by your net worth, income and credit history. The interest rate for this type of loan is usually 0.25% to 1% above the HELOC. Still, a very cheap way to borrow.
When you open a non-registered investment account at your investment broker, you can ask for a margin account. This type of account allows you to borrow up to 50% of the assets’ value in the account. The amount that you can borrow is determined by the type of investments that you own in your account. The riskier the assets that you own, the lower the amount of funds will be available for you to borrow. The other factors that affect your ability to borrow from this account are the product and services that you bundled with your financial institution, your income and credit history. You can get borrowing rates that are as good as an unsecured line of credit if you are one of the preferred clients or at slightly higher rates of 0.25% to 0.75%. Not too shabby eh?
Most of the credit cards out there in the market has an interest rate of at least 19.9% per year. However, I did find a few low interest rate credit cards at about 5.99% to 11.99%. Not be best borrowing rate in the world, but better than most of the credit cards out there. Since I am only using this card as a last resort for my emergency fund and I’ve absolutely exhausted the first three options, this will be my next option. Every percent that I can save, counts.
Most banks offer overdraft protection to their clients on their chequing account. The bank’s pitch is, “If you accidentally take more money out of your account than the amount of money that you have in there, you won’t be charged a $25 Non-Sufficient Funds (NSF) fee if you have overdraft protection.” You can get up to $5,000 in overdraft limit for each of your chequing account. However, when you find out the fees that you’ll be paying it’ll be worst than the low interest rate credit cards. For starters, you’ll be charged $5 per month that your account is in overdraft. The interest rate that you pay amounts to 19% per year. This type of access to funds will never garner any interest from me.
Pay day loans
I don’t want to go into too much details about this, but this type of loan is pretty much like borrowing from a loan shark. I’ll never go into one of these places to borrow money. Enough said.
My two cents
My view on the amount of emergency funds that you should save is quite contrary to most of the so call personal finance experts out there. First of all, I don’t believe in emergency funds. I believe in access to funds (with the five items mentioned above, I have instant access to over $100,000 if I need it for an emergency, see the table below). The argument is, “my emergency funds should work harder than me. So sitting there in a savings account and earning peanuts of an interest rate and I also have to pay tax at the highest tax bracket for the interest earned, does not make sense.” If I have an emergency fund of $20,000 and I still have a mortgage, I would put that amount towards paying down my mortgage. This way, I would earn a higher return on my saving, pay no taxes on the interest that I’ll save from my mortgage interest and I’ll have access to that $20,000 any time I want as I have a HELOC when I setup my mortgage. When it comes to my money, it should work harder so I don’t have to (I wonder if I can apply the same philosophy to my kids one day?).
So, how much emergency fund is sufficient for your needs?