Emergency funds are almost always highly recommended by personal finance gurus and advocates of all types as one of the first financial priorities for any person no matter their financial situation. The rule of thumb is that you should have 6 months of your salary saved up as cash in an easy to access account to bail you out of any large unforeseen expenses, if you happen to lose your job, or if you become ill. Many even recommend building one before paying down potentially high interest debt.
Having an emergency fund is all well and good, but it is a terrible use of money because for it to qualify as an emergency fund the money usually has to sit in bank account somewhere earning negligible interest that is taxable. Putting that money to use paying down debt, like your mortgage, or investing it will get you much further ahead.
But What If An Emergency Comes Along?
Of course, if a real emergency comes along, you do want to be prepared and have some money available to deal with it. Fortunately, for a middle class person or family there are lots of way to access cash in a pinch if you really need it.
Alternatives To An Emergency Fund
Any one of the things I am about to suggest on its own would not be enough to replace an emergency fund because they aren’t fool proof like cash in a bank account. However, my hypothesis is that combining a bunch of these backup plans together can essentially replace an emergency fund if you’re willing to accept a small amount of extra risk.
By the way, cash in a bank account isn’t actually fool proof either … but that’s a subject for another article on another day.
Related: Plan Ahead: My Best Financial Tip!
Home Equity Line Of Credit (HELOC)
A home equity line of credit is an extremely low interest loan that is tied to the equity you have in your house. The amount you can borrow from the bank using this line of credit increases as you pay off your mortgage in a predictable way. You can then access those funds at any time for a very reasonable rate.
For instance, while we owned our first house, we had a HELOC with Royal Bank that had a 3% interest rate for almost the entire duration of the mortgage until we sold the house. As we paid down the mortgage, 80% of the equity we had in the house was available to borrow again through the line of credit. So if we had $50,000 paid off to date, we could borrow up to $40,000 at any time at the 3% annual rate.
The interest rate is always variable and is tied to the prime rate. For us it was exactly the prime rate which held at 3% for a long time. As interest rates rise, this rate would also rise but it is still guaranteed to be some of the cheapest money you can get your hands on.
Unsecured Line Of Credit
An unsecured line of credit is very similar to a HELOC except that there is no collateral to back it up like your house that the bank can repossess if you don’t pay your monthly payments. The interest rate for these loans depends highly on your credit rating but it is still likely to be relatively inexpensive when compared to something like credit card interest rates.
Low Interest Cash Advance
There are many credit cards out there that will give you a low interest cash advance for anywhere from 6 months to a year or more. Interest rates can be as low as 0% + a small cash advance fee which is usually 1% tacked on to whatever amount you choose to borrow.
It’s important to note that cash advances don’t always come with low interest rates and if you do get one, it’s a good idea to ONLY use that credit card for the cash advance otherwise your low interest loan might accidentally get paid off when you think you’re making your payments towards your regular purchases.
To secure a low interest rate, you want to apply for a card that has a promotional low interest rate or call the issuers of the existing credit cards you have and request a low interest cash advance loan. Most credit card companies will have something available for you as they usually send you cheques every month or two advertising a low interest cash advance rate.
Be sure to set a calendar reminder to pay off your low interest loan before the interest rate skyrockets to 20% or more after the promotional interest rate ends. By that time hopefully your emergency has subsided and you’ve been able to pay back the loan, but if not you can use one of the other options to pay it off or take a second low interest cash advance loan and use it to pay off the first.
Skip Payments On Your Mortgage
Many banks will let you skip one or two payments on your mortgage without penalty and for any reason as long as you notify them of the skipped payments. Be sure to take full advantage of this if you have a minor emergency and are really strapped for cash.
Instead of building an emergency fund, hopefully you’ve been using those funds to pay down your mortgage or make some other investment. If so, you will also find that many mortgage lenders will let you skip as many additional payments as you want without penalty as long as you are ahead of schedule on your mortgage. That means as long as you have given the bank more money than you are obligated to at that point in time, you can stop paying altogether until that is no longer the case.
Imagine a scenario where you’ve doubled up your monthly payments, increased your payments every year by 10 or 20 percent, and/or made significant lump sum payments towards your mortgage. This can quickly put your far ahead of the standard payment schedule and you may be eligible to not pay your mortgage for a period of many years. Check with your individual lender for their terms, but I know with my RBC mortgage that this was an option for me.
Liquidate Your Investments, RRSPs, and TFSAs
If paying extra on your mortgage isn’t your cup of tea, hopefully you’ve been putting your extra emergency fund alternative money into investments of some kind. Most middle class Canadians have RRSPs and now TFSAs.
Taking money out of these retirement accounts is often considered taboo and there is even a big myth that you will be heavily penalized for doing so. In reality, unless the account is locked in, which most aren’t, then there is no penalty for making withdrawals other than paying taxes on the money in the case of RRSPs, which you are eventually going to have to pay anyway.
You obviously don’t want to sell investments at the wrong time, but if a real emergency happens and you have no other choice, you can at least cherry pick those investments that have done well and sell those first. That way you are selling high and giving your other investments a chance to catch up. A TFSA account would be the first choice because there are no tax implications or complications and you can redeposit the money back in to the account the following year without penalty as your contribution room is never lost with a TFSA.
If you only have RRSPs, you don’t need to worry that much. One of the main reasons for an emergency fund is loss of employment. If this is the case, your income will be lower for the current year anyway, so withdrawing RRSP money in that year isn’t so bad because you probably won’t be in the highest tax bracket anyway. Like I said, you’re going to have to pay taxes on your RRSP money eventually anyway so you might as well withdraw it on a low income year if you’ve lost your job.
Unfortunately, once you withdraw from an RRSP you can never get that contribution room back unlike with TFSAs, so that is one thing to be aware of. Although, most Canadians are nowhere near close to maxing out their RRSPs anyway, especially now that we have TFSAs, so it isn’t really a major concern.
Use Your Credit Card To Buy Time
Some of the above options may take some time to pull off, so you definitely want to take advantage of the grace period your credit card gives you to give you some quick cash while you decide which option is best for you. You can simply charge whatever expense you have to your credit card and take advantage of the free money until the next payment date which will usually be at least 30 days from the date you make the purchase.
I would never recommend carrying a balance on your credit card because the interest rates are extremely high and you could get caught in a debt spiral, so make sure you have a plan for paying off your credit card before that happens.
Sell Your Stuff
If you are a typical Canadian, you have a lot of things lying around your house that you don’t really need but that have some value. Now is the time to sort through all that stuff and pick a few high value items that you don’t really need and post them on Kijiji, Craigslist, Ebay, or have a yard sale.
Risks To Be Aware Of
There is slightly more risk with this approach than having a true blue emergency fund, but it is minimal. If you are smart with the money you would have been using for your emergency fund you should have even more money available to you than you would have if you had kept it stagnating in a low interest savings account.
Instead, your money has been working for you and the debt savings or investment growth are hopefully substantial and you can use that to your advantage in an emergency situation! Here are a few things to be aware of.
Your Loans Could Be Called At Any Time
Almost all loans given to you by a financial institution can be called at any time because the money is technically their money, not yours, and they have the right to ask for it back when they need it. The chances of them calling a loan early are slim to none because loans are how they make money and they would immediately lose the trust of their customers if they started calling a bunch of loans.
That said, if your credit rating were to become very poor and they become aware of it they might be inclined to call a loan to avoid the risk of default. Also, if your lender were about to go bankrupt they might also call a loan just to keep their business afloat. However, if the loan is backed by your house, you always at least have the option of giving them your house in the worst case scenario.
Your Credit Score Could Fall Rapidly
If you start maxing out your credit lines, taking out cash advances on your credit cards that use up most of your limit, and it becomes known that you’ve lost all of your income, it is definitely possible for your credit score to fall rapidly. This will affect your ability to get any new loans and good interest rates on financial products.
This is why it is a good idea to take out credit lines and credit cards before you actually need the money so you won’t be denied in your time of need. It’s still a risk to be aware of though.
Your Investments Could Tank
If you decided to use your emergency fund money to invest in risky stocks or we have a global financial crisis like in the 2000s, your investments could have lost a ton of money. This make selling them at the time of an emergency a very bad idea.
My preference would be to use your emergency funds to pay off your mortgage so at least you will have a HELOC to fall back on if necessary. If not, hopefully you have at least one safer investment that has avoided steep declines that you can use in the short term.
The Doomsday Scenario
Some of the risks I mentioned above are not likely to happen. If, all of a sudden, all of your loans are being called, your investments have gone nearly to 0, and you have no other means of accessing emergency money, then we all have bigger problems to worry about. That probably means that the Canadian or world economy has failed and your money is now worthless anyway.
For that reason, I tend to view the above options as good enough for an emergency fund in 99% of the cases that could crop up. The other 1% or less just isn’t worth planning for in my opinion. You take a bigger risk driving to work every day or eating the spoiled food in your refrigerator.
Keep in mind, I'm not a financial advisor and you should consult a professional before making any big financial decisions.
Do You Have An Emergency Fund?
If so, would you consider getting rid of it by using alternate means to access funds in an emergency?