HELOC vs emergency fund

[WiseOne]

I'm planning to sell my current apartment and buy another coop for a long list of most excellent reasons that I'd rather not bore everyone with.  I've built a substantial amount of equity in my current place (~50%) and I'm anticipating that it will sell for more than the one I'm buying, even after closing costs.

The coop I'm planning to buy into is extremely well run, but like all coop boards it has all kinds of restrictions.  When I get the financing for the new place, there's a window of opportunity to set up a HELOC without having to get approval from the coop.  Last time, all the coop knew about was the extent of my assets and available cash, the mortgage approval amount, and my planned downpayment.  At the time, I actually put down 25% instead of 20% in order to reduce the mortgage amount, and there was no requirement to notify the coop of this.  The managing agent's representative at the closing technically would have seen this in the large stack of papers being signed, but nobody was looking that carefully.

Assuming this going to be true again, I'm thinking about sinking all my taxable cash (leaving myself with savings bonds, HSA, and Roth cash) into the mortgage and opening a HELOC at the same time. The plan would be to rebuild the emergency fund immediately, relying on the HELOC to handle any crises in the meantime.  This would cut my mortgage payment by a few hundred $$ a month.

Alternatively, I could use the HELOC as a "deep" emergency fund, so that I wouldn't need the extra taxable cash stash I'd been keeping outside the PP.  Instead, I'd simply add savings to the PP and allow the cash portion to rebuild naturally.  I figure that I'd have a pretty comfortable emergency fund anyway after a couple years, so there isn't that much danger of the HELOC being used and the risk window is pretty short.

Just wondering what people thought of these options?

[barrett]

WiseOne,

Much would seem to depend on how secure your income is likely to be over the next few years. Bringing down a mortgage payment by a few hundred bucks a month is nothing to sneeze at. It's hard to quantify the benefit of lower monthly expenses vs. opportunity cost, but cash yields going nowhere at the moment makes this more attractive. Basically you are using the bank's cash as your cash for the time being.

For income security you have to assign some probability to 1) Research funding being cut (don't have a clue how this works), or 2) You may have a health issue and have to take some time off work, and 3) You may decide you just want to change careers, take some time off, etc. Maybe all of those things are really unlikely but taken together they add up to some number.

Just thinking out loud here. As usual I don't really know what the hell I am talking about!

[Mountaineer]

I see it pretty much like barrett.  To me, the purpose of an emergency fund is for the unexpected NOW, not a year or two in the future.  If you can somehow cover the really bad unexpected that might happen in the next 5 minutes after you sink your cash into a non-liquid investment, then go for it.  If not, I'd rethink.

... Mountaineer

[moda0306]

What is the overall marginal benefit of putting more down? 

Just avoiding some interest and lowering the payment, or would you be avoiding PMI or securing a better interest rate by doing so?

If it's the former, I don't think it's worth the risk of losing liquidity, considering your mortgage will be about 3.5% if it's 30 year fixed (guesstimating).  If it's the latter, the IRR implications of going all out on getting more money down could be substantial (use a financial calculator, put the add'l amount down as PV, and the interest/insurance saved as a PMT for a given amount of time, and calculate for IRR... I can do that for you if you want to toss some numbers out there).

If the IRR is high enough, I say perhaps do it.  To me, while it is important to mentally separate your "emergency fund" from other wealth, really, in a true emergency, any wealth you have might very well qualify as an "emergency fund" if it's easy enough to access.  It could very well make all the sense in the world to dip into your Roth if [insert financial emergency here] were to ever occur.

But I'm all for getting the HELOC set up.  They can always take it away in a financial crisis, but it's good to be locked in to a potential liquidity source if it the cost is minimal/non-existent.

Let me know if you want a hand crunching the numbers on the RoR of your decision... if you don't want all those numbers public, you can PM me.

[WiseOne]

Thanks all!!

The job is rock solid for 2 years, I was concerned about potential salary cuts after that but if the tenure thing goes through, I won't have to worry about it.  That's hardly a sure thing though...it's a very high bar.

I looked into the HELOC a little more and was advised to wait until after the closing and go through the coop in the usual way.  So that's also not a sure thing even with all that equity.  Coops usually put strict limits on HELOCs.

PM to moda on its way!  Still the test of being able to sleep at night is the most important one.  Having the HELOC would help with that even if I never touched it.  But also the rates are lower than I thought, so the marginal benefit of loading on the cash is less.

[moda0306]

WiseOne,

Sent you a PM. I hope it's not too unintelligible.

[Libertarian666]

I would NOT do this, because it will leave you vulnerable to sudden economic changes that cause the banks to pull credit lines, just at the time that you might need the money a great deal.

This is for the same reason that I disagree with the notion that holding an emergency fund is "market timing", namely that job loss and economic crashes are not independent events.

[moda0306]

I agree 100% with what tech is saying (nice while it lasted!)

Callable lines of credit, while handy, should be viewed as a potentially toxic resort.  I like them for real quick liquidity needs that will get quickly repaid, but they make for awful emergency funds, considering the very nature of events that pose the biggest risk to people's finances... financial crises.

To expose yourself to that simply for the interest-cost benefits of paying a bit more down on a loan is bad risk-management IMO. 

I could be tempted to the dark side if a bunch of PMI could be avoided, and a lower interest rate obtained for only a modest additional contribution.  But often that isn't what people are getting out of their debt pay-down... they're getting 3% and change.

[WiseOne]

To expose yourself to that simply for the interest-cost benefits of paying a bit more down on a loan is bad risk-management IMO. 

No PMI issues here.  But this statement above...got it, you have convinced me!  The return #s compared to the PP returns were satisfying to see - thanks so much, Moda.

[moda0306]

To expose yourself to that simply for the interest-cost benefits of paying a bit more down on a loan is bad risk-management IMO. 

No PMI issues here.  But this statement above...got it, you have convinced me!  The return #s compared to the PP returns were satisfying to see - thanks so much, Moda.

No problem. I love almost any analysis where I can use my financial calculator.

I don't like to be a doom porner... Just to make sure that if we are exposing ourselves to even very very unlikely risks, we are doing so for some meaningful benefit.

Feel free to toss others my way in the future.

[barrett]

Callable lines of credit, while handy, should be viewed as a potentially toxic resort.  I like them for real quick liquidity needs that will get quickly repaid, but they make for awful emergency funds, considering the very nature of events that pose the biggest risk to people's finances... financial crises.

To expose yourself to that simply for the interest-cost benefits of paying a bit more down on a loan is bad risk-management IMO. 

This thread really got me thinking again about the role of cash in the PP. Specifically, two bad events can often happen at the same time and cash can be a real life saver in those situations. I remember Medium Tex talking about how job losses often happen at the same moment that stocks crash (in which case a stock-heavy portfolio in the hands of a person who has just been fired is a terrible double whammy). A job loss could also easily coincide with HELOC funds just not being available. When things get bad they can often get bad on more than one front.

[moda0306]

barrett,

Not only that, but opportunities can also be very abundant during a financial crisis.  So if other people are losing their jobs and the stock market is going to hell, you might have opportunities with oft-leveraged assets.

The problem is, liquidity and access to lines of credit can be pure garbage for people who aren't trained to handle the behavioral economics of that kind of flexibility.

That, and we tend not to be very strategic-minded during crises.  We panic, and rationalize in ways we never thought we would.

That's why I love HB's advice to "imagine yourself paying the price of a risk."  Really try to walk yourself through the ins-and-outs of your life as it will actually be in a given crisis.  Imagine yourself losing half of your portfolio... while your job prospects dwindle... while your kid can't find a job out of college... while your home value drops... while the majority of your wealth is tied up in said home, but you have a "paid down" mortgage you still owe some on.