EF vs. Debt- WWYD? Ramsey-ites Welcome!

[Belia]

DH and I have no debt other than our house. :

We just refinanced our home to get a lower rate. We now have a 30-year fixed for $380k, and a HEL for $42k. The HEL has a variable rate of prime + 1.5%, which I think is 5.75% now.

We have approx $5000 in savings (our EF).

Over the next 6 weeks or so we will be getting a bonus (for lack of a better term) worth approx $7000.

What should we do with that money????

Before we refinanced, I was planning on putting it toward our EF. In my mind, we need $40k for our EF to be full funded.

But I didn't realize until the closing table that the HEL is a variable rate.... NOT fixed. The interest on that could go as high as 11.5%. Plus, I also didn't realize that the monthly payments we were quoted for the HEL were for interest only and did not include any principal. So now I'm pretty uncomfortable with the HEL and want it gone.

Plus, Dave Ramsey says that the HEL should go into the debt snowball (BS2) because it is less than half of our annual income.

So it should be pretty easy, right??? Pay down the HEL. But that doesn't feel right, either. Why am I hesitating?? Something is rubbing me the wrong way and I don't know whether its a REAL something, or just a general discomfort because I'm changing my plans. I mean, I'm working toward getting on board with Dave Ramsey, but I don't want to be a slave to it if there's something I'm not seeing with my individual situation.

WWYD?

[abckidsmom]

If this is your only debt, Dave would say that you need to pay down the HEL.

That's the easy part to answer. I've also heard him say to many people that if you don't feel comfortable with your EF, or you have any niggling doubt about your security, that the EF is what should get your money. He says that being afraid at night when you go to sleep is worth a little delay when you're basically on track.

You didn't mention your income, but it's generally not recommended that your house be more that ? 25% of your take-home pay...as long as you're around there, you are probably ok. $385k means a big mortgage pmt, which would make me want a bigger EF, too.

[wifeandmom]

Honestly, it wouldn't even occur to me to pay down the HELOC with only $5K in an emergency fund and a mortgage that big. I can't imagine that $5K would even cover two months' worth of mortgage, taxes, and insurance, and that's without the payment on the HELOC.

Put that money straight in your emergency fund. If/when the interest rates go up, and the HELOC interest rates go up as well, you can re-evaluate where you are with your emergency fund.

[Delicateflower]

I don't think you need a $40k emergency fund. I'd put $5,000 into your EF and $2,000 into the HELOC as extra payment.

[Seasons]

Suze Orman would say all $7K should go to your EF: cash is king. (Although she doesn't like secured debt, as your HELOC is.) I trust her advice over Dave Ramsey's.

[Seasons]

Originally Posted by Delicateflower

I don't think you need a $40k emergency fund.

I agree. OP's HELOC is a sorta-kinda EF, too - although it can be closed by the lender, it's harder for them to do so than to, say, close a CC.

[Belia]

Originally Posted by Delicateflower

I don't think you need a $40k emergency fund.

Hmmm..... Really?? I figured that amount by assuming our monthly expenses are $7000 x 6 months = $40k

Although its been a while and I can't quite recall how I got the $7000 number. Our mortgage alone is $3400/month. Daycare is $1400/month.

Sorry if I sound terribly ignorant of my own finances..... I'm just going back to work after a year of mat leave and my paychecks haven't started yet. We also haven't started paying daycare yet. So I've been spending the last 2 months just tracking spending so we can do an accurate budget once my income stabilizes.

Our total household income is $140k.

[i0lanthe]

I would calculate food/mortgage/utilities bare-bones expenses for figuring the 6-months figure rather than how much I spend when everything is ok. I would ask myself how secure the jobs are. Then I would probably put the bonus in EF and let fear-and-loathing of the HEL motivate me to work hard at snowball creation.

[annethcz]

In your position I would stick the money in an emergency fund. That $5k is going to run out awfully fast if either you or your DH loses your jobs. A $40K EF sounds completely reasonable given your expenses. While you may be able to save on daycare costs in the event of a job loss, you may end up paying for COBRA- the two could easily cancel each other out.

I also wouldn't be *too* concerned with the variable interest rate right now. Interest rates are quite low at the moment and they will probably stay that way for at least the short term future. If your interest rate skyrockets, you can choose to pay down the HEL at that point.

[Marcella_Moxley]

Yes, 40k is a completely normal Big Emergency fund -if you have 7000.00 in monthly expenses, thaen right now you don't even have one month of emergency money put away yet.
I like the point the other poster brought up, even if you have no daycare to pay. you need to pay cobra, which is likely the same amount. Also, some people need to keep their daycare even in the event of a job loss to save the spot, or to spend time interviewing. What do you do with your kids if you are home with them and you are called to come in that day for an interview?

I would save the 40K in the Big EF, and then work on getting rid of the HeLoc after that.

[samandhenrysmom]

I would put the bonus in an EF and then start paying off the HELOC as quickly as possible. You will be able to pay a large amount each month and get it done soon. Then fully fund your EF.

[siobhang]

the HELOC interest is tax deductible, so it is "better" than other sorts of debt, esp if you are under AMT. I ditto the other posters and say put it in your EF.

Also, you don't say whether you will pay tax on that bonus - if so, you may want to find a tax deferred savings, like an IRA, which are still an asset you can borrow against if you find yourself in need of more money.

I would try to pay off the principal off your HELOC, by just upping the monthly payment every month as much as you feel comfortable.

[A&A]

Why are some people calling the HELOC an emergency fund? It's a LOAN AGAINST YOUR HOUSE. AND HELOCS, in a lot of cases, put you upside-down in your house (where you owe more than it's worth). The sooner you pay it off, the better.

[Kyamo]

Originally Posted by A&A

Why are some people calling the HELOC an emergency fund? It's a LOAN AGAINST YOUR HOUSE. AND HELOCS, in a lot of cases, put you upside-down in your house (where you owe more than it's worth). The sooner you pay it off, the better.

It's not really an "emergency fund", however if there was an emergency, money could be borrowed in the HELOC to cover it. Example of why it is not as stupid as it sounds to consider this: Imagine I had 10k now, and a 30k HELOC. Situation 1: I keep the 10k for my emergency fund. 1 year from now there is an emergency that costs 10k. Emergency fund is gone and HELOC is still 30k minus payments over the year plus interest.
Situation 2: I pay down the HELOC with the 10k. 1 year from now there is an emergency that costs 10k. I borrow from my HELOC, and the HELOC is back at 30k minus the years payments plus interest.

That makes it look like I come out even either way, but the difference is that in situation 2 I am paying interest on 20k, and in situation 1 I am paying interest on 30k, and earning a lesser interest rate on 10k. So unless you somehow have a higher interest rate on your savings account than your HELOC, situation 2 comes out ahead, despite relying on the HELOC as your "emergency fund".

ETA: How can HELOCs put you upside down, I thought the max you could borrow was the value of the house (or less, depending on credit limit bank gives you)? Do you mean if you have borrowed close to the full value then the value drops? In my case, that's really not a concern, as even if we borrowed the max our bank will let us, we still have around 70k equity left over.

ETA2: I am talking ONLY about the situation where money that could be going to the emergency fund is going to debt instead.

[annethcz]

Originally Posted by Kyamo

It's not really an "emergency fund", however if there was an emergency, money could be borrowed in the HELOC to cover it. Example of why it is not as stupid as it sounds to consider this: Imagine I had 10k now, and a 30k HELOC. Situation 1: I keep the 10k for my emergency fund. 1 year from now there is an emergency that costs 10k. Emergency fund is gone and HELOC is still 30k minus payments over the year plus interest.
Situation 2: I pay down the HELOC with the 10k. 1 year from now there is an emergency that costs 10k. I borrow from my HELOC, and the HELOC is back at 30k minus the years payments plus interest.

This assumes that the HELOC is still open 1 year from now. The bank can close the line of credit at any time.

[Belia]

Originally Posted by annethcz

This assumes that the HELOC is still open 1 year from now. The bank can close the line of credit at any time.

Which is what happened to us 2 years ago. When we first bought this house we opened a HELOC at the same time... at first to bridge the gap until our previous house sold. We paid it off in full but wanted to keep it open in case of an emergency (after all, at least we could deduct the interest) or we wanted to remodel something.

After having it for less than 6 months and never drawing on it again the bank closed it due to the real estate market tanking. Total bummer.

I think I'm now leaning toward putting the cash in the EF, and y'all have made me feel better about it. Now to convince DH.

[Carson]

With those monthly expenditures, I would think the information on saving the money could be pretty black and white to your DH. Not sure how your income is segmented between the two of you, but can you get the dollar figure on if he loses his job, how long that $5k would cover the gap between your two salaries and if you lost your job, how long the $5k would cover you?

Do you have a plan for paying down the HELOC? I would suggest you get your EF to a point where it wouldn't cause you major panic (only you know your stripped down expenses, incomes and job loss likelihood) and then agressively pay it off.

I personally have done what previous posters suggested. I treat my EF as sacred and have borrowed against (and subsequently paid off) my HELOC as needed. It also is variable interest rate and interest only payment. For me, it's just incentive to pay it off as soon as possible (now that we do have a decent EF)

[Crunchy*VT*Mom]

We are facing EXACTLY the same situation you are facing right now...and I've been mulling over the same question.

We have a HELOC that is less than 50% of DH's yearly income, but our emergency fund isn't quite up to 6 to 9 months worth of income.

So where to put it?

I decided on the emergency fund.

IF the rates on the HELOC go up, that money is in the emergency fund and I can shift it over.

[A&A]

Originally Posted by Kyamo

ETA: How can HELOCs put you upside down, I thought the max you could borrow was the value of the house (or less, depending on credit limit bank gives you)?

.

Some lenders allow a second mortgage that is up to 120% of your equity. (At least they have in the past.) That's how my MIL ended up upside-down in her house from the start. (And now the dropping market doesn't help her, of course.)



and according to this link:

http://money.cnn.com/2009/08/06/real...derwaterworld/

"Nearly half the nation's mortgage borrowers will soon owe more on their mortgages than their homes are worth, according to a new report.

A Deutsche Bank analysis of the battered housing and mortgage markets estimated that 25 million borrowers, representing 48% of all Americans with mortgage loans, will plunge underwater before home prices are expected to stabilize in the beginning of 2011."


not a good time to be having second mortgages and HELOCS, imho.

[wifeandmom]

Originally Posted by Delicateflower

I don't think you need a $40k emergency fund. I'd put $5,000 into your EF and $2,000 into the HELOC as extra payment.

$40K might sound like a lot to have in an emergency fund, however the OP's mortgage and childcare alone add up to nearly $5K per month. That $40K would be GONE in roughly 8 months if they paid nothing but those two things every month. At the estimated $7K/month expenses the OP says she figured, it would last 5-6 months. I'd say $40K would be the minimum to aim for in their situation.

Originally Posted by Kyamo

It's not really an "emergency fund", however if there was an emergency, money could be borrowed in the HELOC to cover it.

Anyone would be FOOLISH to assume that any line of credit would still be available tomorrow, much less a year or more from now. Creditors can, do, and ARE closing accounts and lines of credits with no warning whatsoever.

Let's say she pays the $5K to the HELOC. Great. That "frees up" $5K in credit should they have an emergency, right?

Well, maybe. Maybe not. What happens if her bank decides next week to close the line of credit or lower the limit to just above their current balance? She doesn't get that $5K back, and she certainly cannot assume she could run out and open up a new line of credit or credit card if she truly needed it.

There is a reason that financial gurus like Suze Orman are deviating from their "get out of debt asap" advice and suggesting people build up their emergency fund first.