This is the second part of a three part series. The first and second parts of this mini-series can be found:
This next part of the series is contributed by Phil Taylor, creator of PT Money: Personal Finance. These are his thoughts on alternatives to the traditional savings account for holding an emergency fund.
A wise first step in any financial plan is to have a bit of easily accessible cash in the case of emergencies. This will help you avoid depleting your checking account when you face an emergency financial situation. It will also help you avoid having to resort to credit to help you out. Conventional wisdom says to put this money in a place that’s easily accessible and safe. But there are alternatives to this approach. And you can either plan to use one of these different directions, or you can resort to one if you’re not prepared with the traditional approach.
Home Equity Loan – If you have equity in your home (the value is more than 20% of what you owe), then you can pretty easily get a loan using this equity as the collateral. Getting this loan might take more than a few days, however. And because it’s a loan, you’ll need to pay interest to the bank when you are paying it back. This debt is similar to your mortgage in that it’s tax-deductible.
Credit Card – If you have room on your credit card, then this can serve as a temporary emergency fund. Of course, unless you take advantage of some promotion, you’ll have to start making payments right away not to mention credit card interest charges are through the roof. You also have to remember that if you have to max out your credit cards it will hurt your credit score.
401K Loan – If you have money saved in a 401K or 403b, you likely have access to a loan against those funds. You are borrowing against your own money, so what payments and interest you have to pay back are going back into your account. However, when you have the funds borrowed you usually can’t make contributions. And if the market sees a big up swing, you’ll miss out on potential gains. Remember that your 401K is for retirement, not credit.
Cash in a Safe – You could just keep your money under the mattress at home, or in a safe. The problem with this approach is that the funds aren’t insured. So if your house burns down or the safe gets taken, there go your funds. Homeowners insurance might be able to help you but odds are they won’t replace 6 months of expenses (typical emergency fund amount) for you. I’m a fan of keeping a little bit of cash in a safe but not the entire emergency fund.
Roth IRA Withdrawal – Finally, if you have funds in a Roth IRA, you can withdraw the contributions at any time without tax or penalty. There are even certain Roth IRA brokers that will let you keep your funds in a CD or other FDIC insured account. On the surface, this seems like a good approach. Does anyone out there use this method? I’m still against it because it uses a retirement account for something other than retirement. (Note from Jesse: you recall earlier in the series I discussed using a Roth for an emergency fund investment vehicle. Check the second part of the series to get the details, and be sure to share your thoughts in the comments about this approach!)
Most of these ideas come in a distant second, in my opinion, compared to a fully-funded emergency fund in a liquid, high-interest savings account. There really is no better tool to cover your expenses when you experience a job loss, major out-of-pocket medial situation, or other unexpected expense. But everyone’s situation is different, and one of these approached may work for you better.
What do you think? Do any of the options during this three part series interest you? Do you already use any of them?
Image by AMagill br>
Tags: 401k, checking account, collateral, conventional wisdom, credit card interest, credit cards, credit score, emergencies, emergency fund, few days, financial situation, home equity loan, interest charges, mini series, money, mortgage, personal finance, phil taylor, traditional approach