# Access to credit vs. emergency savings



## Maybe Later (Feb 19, 2011)

I want to throw something out there that many won't agree with, but I'd like to hear your thoughts. I am very open minded about this.

We have access to a substantial line of credit because we have significant equity in our home. Additionally, rather than build up a big savings cushion for one-time costs we throw extra money against the mortgage every month. The numbers aren't exact, but for the sake of arguement it is $1000 a month and every inflated payment takes an additional month off the mortgage of about the same.

If I had a one-time emergency of $10,000 and I were to put it on the LOC and carry it for a year it would cost less than $400 in interest charges.

If I put $1000 a month into an emergency fund for 10 months, it would extend my mortgage by 10 more months, costing me $10,000 (give or take).

You'll notice I'm not advocating not saving at all (we do have retirement, education, other savings), but pointing out that we all need to think about our own personal situations, particularly when receiving advice from others. Likewise some will also point out that if my $10K were invested in a HISA, or other very safe, accessible product, then it would actually be growing, not sitting gathering dust. Also true. There are some other assumptions, like I could pay off the $10K in a year (likely) and would choose to do so (also likely) and would not be directing that money elsewhere, including against the mortgage had the emergency not occurred (who knows?).

The reason we do it? We're comfortable with it. The same reaon we're not levereging the LOC to invest. Not that comfortable at this stage in life, but very confortable with the idea intellectually.

I post because just as we need to consider our own situation in receiving advice. We could also look at our own assumptions before dispensing it because what works for you, might actually be worse for me.

Your thoughts?


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## slacker (Mar 8, 2010)

LoC is a lower level of safety than real cash. Banks "could" take it away and call in your loan when you need it most. It comes down to what level of safety you can afford.

Not everyone can afford to have $10k just sitting somewhere.


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## hystat (Jun 18, 2010)

I have heard the savings argument several times and it never spoke to me. 

I have always relied on home equity as my cushion. Now that the house is paid off, the l/c still sits there with about 50% of my house's value available. A few years ago, I was sitting around a picket line with coworkers and they were saying how long they could go without a paycheck. Most were talking weeks...I said nothing because the figure in my head was about 7 years. -as long as I calculated the home equity would support me until the house was fully mortgaged again (75%)

Banks are public companies with a responsibility to their share holders to seek good business. They aren't going to refuse to lend me money on this house. 

Every situation is different. I don't know what type of lines of credit banks just close up on people... maybe If you live in a remote area, or a mining town with a resource that is no longer valuable. The kind of thing where much of the home's value could vapourize. 

But if someone has, say, a brick bungalow on a bus route in suburban GTA, seems to me any bank would jump at a line of credit if it is a first mortgage.


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## marina628 (Dec 14, 2010)

The only reason i sit on so much cash is that we have 5 rental properties , if i only had one house and cottage I probably would not feel the need for so much cash on hand.But we have always as long as i can remember have about 1 months expenses in physical cash on hand.


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## Dmoney (Apr 28, 2011)

I know a mortgage and a line of credit are two different beasts, but I agree with the OP's strategy. Essentially, you are opting to pay off debt quickly, which means the worst that can happen is if you have a $10,000 emergency and you draw on your line of credit, you simply return to where you would have been prior to paying extra on your debt.

If your mortgage was paid in full and you were fully debt free, I might say it's a better idea to have cash on hand rather than rely on access to credit in emergencies, but what you are doing is rapidly paying down debt, and if an emergency happens to come up, you'll have greater borrowing capacity anyway.


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## DanFo (Apr 9, 2011)

The only danger in relying on a LOC for an emergency is when that emergency effects your ability to earn income, in this scenario you lose the ability to make payments on that borrowed money..... at the very least increasing interest payments you'll pay on that debt, at worst making you lose your asset (house)


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## the-royal-mail (Dec 11, 2009)

Yes, racking up debt at the same time as you've lost a major source of your income is a very bad idea. After the crisis passes, it will take you several years not only to pay back that debt but also to build back any reserves you may want to have.

But more generally, I have a problem with this because it means YOU are not in control of your finances. When you have money saved in the form of liquid assets (cash, TFSAs, cashable GICs, physical currency in the mattress etc), YOU are in the driver's seat.

I also have a problem with paying interest to borrow money that is essentially mine (as in the OP's case of borrowing against home equity).

A friend of mine went through a divorce several years ago. The moment the bank found out, they yanked out his LOC from under him so he couldn't borrow.

So while I understand what the OP is saying, I simply cannot accept the justification offered for not saving money during good times, to prepare for the bad times.


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## andrewf (Mar 1, 2010)

^ Of course, people who maintain cash hoards will have lower retirement savings, all else being equal.

What I mean is your choice for a given level of income and consumption is small cash reserve and greater long term investments, or big cash reserve and less long term investments. To the extent there is a spread between cash returns and long term investment returns, that spread times the cash hoard is your annual 'cash pile insurance fee' in foregone invesment return. If you have a low probably of losing income, etc. it's probably more sensible to err on the side of more long term investments. If you have highly uncertain income, such as a contractor or other self-employed, it might be quite sensible to keep significant amounts of cash or short-term bonds.


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## marina628 (Dec 14, 2010)

A friend of mine took a $50,000 HELOC to max her RSPS then she got married a year later to a man who had no money of his own and who had a house that needed serious work before they could sell it.She went to her Heloc and put $80,000 into his house then to find out his son was also on title .Now the son won't sign to get house sold and she is paying interest and all the payments on $130,000 HELOC .People spend heloc like it is their cash and forget you are going in the hole when you use it.


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## Gandharva (Jul 14, 2010)

I am planning to do as the OP is describing. I have a year's worth of living expenses in cash, and from now on any monthly surplus will be put towards the mortgage. The goal is to be debt free in 3-4 years so we can buy a bigger place (and start the process all over again). In reality we may sell sooner though.


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## Lephturn (Aug 31, 2009)

You are doing what you are comfortable with, which is always important.

That said... I would personally do the opposite. I don't put a dime into my mortgage until RRSP, TFSA, and RESP for the kids are all maxed. I'm in variable mortgages (2 properties) paying 2.1% interest. My payments are set as if I was in a 4.5% fixed mortgage, so I am already accelerating the payments to substantially, but anything extra goes to tax sheltered investments before they go to paying down debt that's running at 2.1%

In terms of credit vs. emergency savings, I do have a HELOC available for that purpose, as well as a higher interest unsecured LOC. Assuming you have the discipline not to dip into the LOC so that it is available for a real emergency, I think that makes sense.

I am unlikely to pay down debt at 2.1% - I am comfortable that I can beat that return handily investing, so it wouldn't make sense. If interest rates get much higher, that would change - and I can always take any unregistered investments and pay off the debt in the future if it makes sense to do so.


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## dogcom (May 23, 2009)

Be your own master as suggested and protect yourself with cash in an emergency fund. Gambling on a LOC is fine if you want to but just remember it is still a gamble of some sort. No one can be trusted, bankers included so you must rely on yourself for almost everything when it comes to money.

So always start with a trust no one stand and that way you will check everything and everyone out so you don't get screwed in life. This is the angle I use so in my case I would have emergency cash on hand and would maybe use my LOC first and then my emergency money to hold out as long as possible if disaster hits me.


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## andrewf (Mar 1, 2010)

marina628 said:


> A friend of mine took a $50,000 HELOC to max her RSPS then she got married a year later to a man who had no money of his own and who had a house that needed serious work before they could sell it.She went to her Heloc and put $80,000 into his house then to find out his son was also on title .Now the son won't sign to get house sold and she is paying interest and all the payments on $130,000 HELOC .People spend heloc like it is their cash and forget you are going in the hole when you use it.


HELOCs can be dangerous in the hands of people who don't make good decisions. The problem here was bad decision-making, not the line of credit. It would have been a really dumb decision if it had been cash, too.


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## Cal (Jun 17, 2009)

I would rather pay off the mortgage 10 months earlier. And use the HELOC as the emergency fund, no emergency, no interest. If you are putting and extra 1K ion your mortgage every month, you obviously have some financial responsibility. 

I would use the HELOC for investing when the mortgage is paid off, but that is just my comfort level. And I personally wouldn't use all of the HELOC that the bank is offering, maybe only 1/3 of the property value. I err on the side of caution when it comes to debt.


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## Eclectic12 (Oct 20, 2010)

andrewf said:


> HELOCs can be dangerous in the hands of people who don't make good decisions. The problem here was bad decision-making, not the line of credit. It would have been a really dumb decision if it had been cash, too.


Agreed ... though there is one difference. It it had been cash, they'd have been out the cash. With the HELOC, there's the interest on top of the cash.


Cheers


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## cannon_fodder (Apr 3, 2009)

marina628 said:


> People spend heloc like it is their cash and forget you are going in the hole when you use it.


*Some* people. And that is why the OP's strategy is risky with many people yet defensible in certain situations.

I've never created an emergency cash pile. Here are some factors I consider:

- have you had a long history of continuous employment with income that at least keeps pace with inflation?
- do you have a 2 income household and is there a low correlation between your jobs' stability?
- are your non-discretionary household expenses less than either of your incomes?
- do you have significant assets that are relatively liquid (e.g. held in TFSAs, non-registered accounts)?
- are you unlikely to add children to your family in the near term?

If you take the approach that a LOC is better than an emergency fund, you still may want to have funds set aside for: annual vacations; house repairs; replacing a vehicle, etc. These types of expenses may occur regardless of whether you lose or significantly reduce your job income. Personally, I separate an emergency fund (up to six months of non-discretionary expenses in case of job loss) vs. planning for anticipated expenses that can be somewhat predictable, even scheduled.

Having an emergency fund isn't a bad idea. If nothing happens, it wasn't the fiscally optimal solution but there is no way to know that until after.


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## MoneyGal (Apr 24, 2009)

Nice list and analysis, CF.


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## Four Pillars (Apr 5, 2009)

Here are my thoughts on emergency funds and my 180 on them:

http://www.moneysmartsblog.com/why-i-have-an-emergency-fund/


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## andrewf (Mar 1, 2010)

I'm not anti-emergency fund. I just doubt rules of thumb that say everyone should have 6 months. Some people might need more, others less.

Most people having working cash. My working cash usually amounts to three or four months of my non-discretionary spending, so I have an emergency fund despite not really trying. I have no debt and I have a high savings rate that I use to contribute to RRSP and TFSA. In the event that I need money, I can raise some from TFSA (it is not verboten to sell longer term assets--it's just there's a chance that when you need the cash it may be inopportune to sell), or borrow cheaply. I don't have dependents. I'm a case study in someone who doesn't need much of an emergency fund. I can definitely envision a time when that might not be the case.


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## Sampson (Apr 3, 2009)

andrewf said:


> Most people having working cash.


Is it a little geeky to think of this as operating capital? My wife rolls her eyes whenever I refer to our family 'revenue'.


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## Maybe Later (Feb 19, 2011)

Thanks for all the thoughtful replies. I also appreciated your blog post Mike.

Just to illustrate how situational I look at this:

We're starting to contemplate a change in lifestyle that would probably include a move. If we were to decide that a move was in the cards I'd stop the extra mortgage payments and keep that same money fairly accessible.

Again, the reasons are as much emotional as anything. If I'm not going to live here to burn the mortgage, being done 10 months early is neither here nor there. I might bring the mortgage with me or it might stay with the house. And of course, if we were to move in the next year or two a pile of cash would be much more flexible than a HELOC that would close with the sale of the house. 

That said, I completely agree with cannon_fodder's assesment that it can be risky for some, but defensible - and I would extend that to even mildly advantageous - for others.


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## andrewf (Mar 1, 2010)

Sampson said:


> Is it a little geeky to think of this as operating capital? My wife rolls her eyes whenever I refer to our family 'revenue'.


I've been accused of worse things than being a little geeky!


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## Guigz (Oct 28, 2010)

slacker said:


> LoC is a lower level of safety than real cash. Banks "could" take it away and call in your loan when you need it most.



I dont understand this. I was speaking to my mortgage advisor at BMO (we are thinking of refinancing to get a better rate and re-advancable mortgage) and I was questioning her about the line of credit portion of the re-advancable mortgage.

I straight up asked her if the loan was callable and she told me no. The line of credit portion is not callable by the bank and is available anytime even after the mortgage is paid off. 

Was she lying or is there something I am missing? How is that loan callable?

I understand the implied risk in this case is if you are fully leveraged and the house value drops come renewal time you might be screwed.


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## the-royal-mail (Dec 11, 2009)

Guigz, I mentioned in another thread recently (you may have missed it) where a friend of mine went through a divorce many years ago and the moment the bank found out they cancelled his LOC. That story should be enough to inspire anyone to ensure they have sufficient cash reserves to weather a storm.

A LOC is a very valuable thing. Sometimes even cash reserves aren't enough and so you need to also rely on your LOC. I've been through that but my point is that the more cash you have saved in advance, the safer you are and farther away you are from racking up debt. Remember, interest rates will only increase in the future. LOC interest rate for me right now is around 6-7%.

Also remember that when you borrow from any credit line, you are instantly creating debt for yourself. Why do that if it can be prevented when times are good?


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## Lephturn (Aug 31, 2009)

Guigz said:


> I straight up asked her if the loan was callable and she told me no. The line of credit portion is not callable by the bank and is available anytime even after the mortgage is paid off.
> 
> Was she lying or is there something I am missing? How is that loan callable?
> 
> I understand the implied risk in this case is if you are fully leveraged and the house value drops come renewal time you might be screwed.


While it is not set up as a "callable" loan, the agreements always have an "out" in them for the bank. For example, my HELOC with TD a couple years back they just "decided" to change the rate on it... of course to increase it by .5 %. Trust me, they have language that says they can change the deal whenever they want.


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## slacker (Mar 8, 2010)

@Guigz: I cannot provide advice on your loan. Please pay due diligence.


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## CanadianCapitalist (Mar 31, 2009)

Guigz said:


> Was she lying or is there something I am missing? How is that loan callable?


Look up the loan agreement you signed. I bet you there is wording there that says the bank can call the loan at any time for any reason. I once had a secured LOC with RBC and the loan agreement contained words to that effect.


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## Guigz (Oct 28, 2010)

CanadianCapitalist said:


> Look up the loan agreement you signed. I bet you there is wording there that says the bank can call the loan at any time for any reason. I once had a secured LOC with RBC and the loan agreement contained words to that effect.


To be fair, I did not sign it yet, I am still shopping around. But I will definitely ask to see the paperwork first.

Another somewhat related question:

I asked about being given the details of the calculation for the penalty for breaking my mortgage and the rep told me that she did not know how it was calculated. She also told me that even the manager does not know how it is calculated.

Is this standard bank practice? Can I force them to give me the details on how they calculate it?


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## randomthoughts (May 23, 2010)

I don't think it needs to be all or nothing - while I'm an advocate of having an emergency fund, while I had a mortgage it was only about a months' worth and I doubled the payments on the mortgage.

One of the nice things about RBC mortgages is that for each payment that you double, you can skip in the future. This gives a bit of added security... your emergency fund can leave out the mortgage.


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## dogcom (May 23, 2009)

For god sakes have a little liquidity if the s-it hits the fan.


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## the-royal-mail (Dec 11, 2009)

I agree dogcom. I am a bit disturbed lately at all the threads lately looking for validation of going through life without e savings. The obsession some have with "paying off" things is quite unhealthy but it seems some people need to learn the hard way. I've been trying to save people from having to learn these hard lessons firsthand, but what's the old expression about leading a horse to water? Can't make him drink.

Then after they've paid off everything they want to start investing right away. Still without e funds to protect them and their families. *shakes head*


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## Maybe Later (Feb 19, 2011)

@dogcom & TRM: this is my point about one shoe not fitting all. Painting everything with the same brush does not take all the factors into account. Would you give the same advice to someone who had $0, $10,000, $1,000,000 accessible investments just because?

Interestingly no one has mentioned other ways of mitigating risk. Do I need the same level of emergency savings if I am: not insured? Under-insured? Adequately insured? Over-insured? Financially independent? I think not. However, this rarely comes up when people start talking savings. 

Thoughts?


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## Plugging Along (Jan 3, 2011)

I do agree that one solution doesn't fit for all. TRM's 3 tiers is generally good advice for many, but I believe we're an exception. We don't have 12 months cash, plus a second tier (we do have our tier 3 well established). However, that being said, we have enough funds that in case of an emergency we have enough to last us at least a year. We just don't seperate it out as TRM suggests. Though I do understand his sentiment, that you have to plan for things.

The amount of emergency fund really depends on many risks. Someone who is fiananciall secure already has a fund built in because being financially secure implies that you have enough money to cover off all your living expenses, and all emergencies any ways. So that wouldn't apply. 

I don't think insurance really applies to the equation for emergency funds, because generally insurance isn't for when you loose your job. It's more for if you're dead, and then it doesn't matter the same way. If it's for illness or disability, you still need an emergency fund. It takes time to collect the money, and you can bet the insurance companies will do everything they can to stop you. 

So here are my general thoughts on emergency funds and credit.
First, Cannon made a very good list of the risks. You also have to factor the stability of your relationships, if there are dependants involved, if you will need the money any time soon. Does your mortgage have flexibility, or will you lose the house if you miss a few payments.

I think the other thing is what do you consider an emergency fund. I hear people say that they will use their LOC for emergencies instead of savings. If emergencies are repairs to your house or car, then in my mind these are not emergencies. These are things that can be planned for. Generally, people know that their will be repairs that are needed, but yet are surprised when it happens. The OP said it might be better to just pay the one time emergency of $10K, I have found in my experience emergencies are often aren't just one time. Sure the flooding of the house, or natural diasters will be covered by insurance. I think of emergencies of when you will not longer be able to work or job loss. This is where a real emergency fund is required. Being on mat leave, while my spouse was laid off a month after our child was born, and having issues with our rental, and our equities dropping down by just over 50% made me realize how important an emergency fund is.

It's usually these types of things that sink a family. It's because they start to get into debt (perhaps through no fault of their own), then it just starts to snowball. There is no emergency fund, so debt (LOC) is used to pay off other debt (Mortgage), the new debt is increasing, and very little is being paid, and any gains you would have gotten from paying off your mortgage 10 months earlier is more than lost. I honestly think that once you start sinking, it's hard to get out. Then there is the emotional and pyschological aspect. Can your marriage handle the stress of not knowing where the money is coming from? My spouse was extremely stressed, and it took a huge toll on his well being knowing that there was no money coming in with two kids. That was with funds that would last us over a year. I could only imagine the stress if we were going into further debt every month. This is the one aspect that I do not wish for anyone. Perhaps if you are single and have no dependants, this isn't much of an issue. I know when we thought we would have to lose our wonderful childcare or school for our child that once we cancelled would never get back, it tore us apart.

I think you need to take a look at the individual situation. Right now, I'm actually thinking of depleting my cash funds and investing more, or paying off our vacation place. I'm weighing all the risks right now. For us, I am trying to pay it off in the next three years. My strategy is do a combined approach. I want to make the extra 20% payment each year, but I am doing in a yearly lump sum. I could technially pay off my whole mortgage right now, but would end up with no cash on hand. Instead, I will set a side larger lump sum payments which I will make at the year end if the risks seem appropriate. This way I am never without any emergency cash, but my reserves will continual build each year and deplete at the end of the year. 

When talking about risk mitigation (which is really what an emergency fund is), you need to determine what your risks are, and how would you manage them if they happen. Insurance is another, but if LOC is your only plan, you could be in for a surprise. The only thing for sure is crap happens, just when and what.


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## Maybe Later (Feb 19, 2011)

Very good post PA. 

I guess if I were to use Royal's three tiers, I would suggest that I'm talking about Tier 2 - or as I think of it, the Oh Sh!t fund. Oh Sh!t, a tree just fell on my car! For some that may be an emergency. For others, an unexpected expense. In my case that would be a real problem, but one I could handle with a LOC and still be ahead at the end of the day compared to sitting on a pile of cash. 

I would also argue that insurance plays a major role in determining how much emergency savings we all need. It limits the number of possibilities where there might be an emergency. I would put "can't work" as a higher risk than "lose your job" for many. 

My biggest point is that it is situational. In the, "Are you a stock or a bond?" sense of things my job is as boring a bond as you get, which impacts what my cash flow decisions are. 

In my position, increased disability insurance might be more important than a cash pool. 

It also occurs to me as I write this that my viewpoint is probably colored by the idea that if I were back to square one tomorrow, without a penny to my name, I'd be OK.


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## andrewf (Mar 1, 2010)

I guess I address financial risk not by having a large cash hoard to mitigate risk, but by being very careful about taking on the risk in the first place. I have no car payments, I have no mortgage. I have no student loans. If I lost my job, I could live for several years (rent + food and other essentials) on my current savings. I just don't bother keeping them in cash. I probably have a lot less financial stress than most people.


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## Plugging Along (Jan 3, 2011)

Maybe Later said:


> I guess if I were to use Royal's three tiers, I would suggest that I'm talking about Tier 2 - or as I think of it, the Oh Sh!t fund. Oh Sh!t, a tree just fell on my car! For some that may be an emergency. For others, an unexpected expense. In my case that would be a real problem, but one I could handle with a LOC and still be ahead at the end of the day compared to sitting on a pile of cash.
> 
> I would also argue that insurance plays a major role in determining how much emergency savings we all need. It limits the number of possibilities where there might be an emergency. I would put "can't work" as a higher risk than "lose your job" for many.
> 
> ...


I think these things all add to your own risk profile. We just had a rock hit our oil pan, which then leaked out, and almost recked our transmission and our clutch. It was covered from insurance, we still had to pay the deductable, and the amount for the depreciated value for the clutch. I think things like these happen often (not the clutch), but where you have to have unexpected pay outs. For us, losing a job is much higher, as my spouse is self employed. We're not in physical jobs, so we're less likely to have to wory about disability. I would also check what kind of disability is covered. 

I think the key part you mentioned, is if you didn't have a penny to your name, and went bankrupt or something, you'd be okay. So I will assume that you don't have dependants. This is really quite huge. For us, having kids brings in a huge part of risk. The actual probability of risks occurring stays the same, but now the impact of not making the payments becomes larger. In your case, if you're comfortable with losing it all (not to say that you would, but you need to look at the worst case), then you may not need the emergency fund. 



andrewf said:


> I guess I address financial risk not by having a large cash hoard to mitigate risk, but by being very careful about taking on the risk in the first place. I have no car payments, I have no mortgage. I have no student loans. If I lost my job, I could live for several years (rent + food and other essentials) on my current savings. I just don't bother keeping them in cash. I probably have a lot less financial stress than most people.


That again, comes down to impact when looking at the risk. The amount of emergency fund you require is much less because you have less expenses, but that doesn't mean you don't have an emergency fund. If you didn't have a dime in savings, and was unable to work, then you would need to go into debt (even though it would be relatively small amount) to live. The question is if you are comfortable with this. I actually didn't have much of an emergency fund when we were first starting out. We had low expenses, and our expenses were cheap. I was actually told that was the best time in our lives to take huge risks (financially), and start businesses, and be an entrepenuer. If went bankrupt, we had time to rebuild, and not much to lose, and no kids to depend on us. That was when my spouse decided to start consulting. Now, my kids depend on me, and I have enough of an emergency fund that covers our main living costs, but have included school tuition and childcard in there too as part of it.


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## Maybe Later (Feb 19, 2011)

Plugging Along said:


> I think the key part you mentioned, is if you didn't have a penny to your name, and went bankrupt or something, you'd be okay. So I will assume that you don't have dependants. This is really quite huge. For us, having kids brings in a huge part of risk. The actual probability of risks occurring stays the same, but now the impact of not making the payments becomes larger. In your case, if you're comfortable with losing it all (not to say that you would, but you need to look at the worst case), then you may not need the emergency fund.


Funny you should mention kids. We have two, and if two pink lines yesterday morning are to be believed, a third on the way. 

I think it is (possibly misplaced) confidence that colors my outlook. I can't think of a reasonable scenario where I would lose my job, short of doing something illegal or immoral that would get me fired. If all my bank accounts were at zero and I could work, we'd be OK. I also have a very good social safety net (family) that would keep us sane. The most likely scenario is I would choose to look for something else in another province. 

As far as insurance, I'm not thinking it likely that I'd be hurt at work, though that is a possibility. I think it just as likely that I get in a car accident or get some illness. In my line of work, it would have to be a pretty serious disability before I couldn't come back to my job in some fashion. Insurance could protect the cash flow for that period. 

Actually disability insurance is the one I have the most problems with. Loss of income would be easy to plan for, but extended medical costs for home care and the like? Getting pretty far from unexpected expenses for car and home repairs, but it is an interesting discussion. Thanks.


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## the-royal-mail (Dec 11, 2009)

MaybeLater, I'm not sure how old you are but the opinions you express display a certain naive notion of what happens in life. I do not know why you are trying to muddy the waters with a discussion about insurance. Insurance will not protect you against job loss, roof leaks, a rotten boss, a damaged oil pan on your car, major dental work for little johnny and other such expenses. It sounds to me like you are rationalizing in your mind that hoping for the best and not doing anything illegal absolves you of the need for an e fund, and that insurance will cover the rest. That is a very irresponsible view of life and to depend on credit to keep food on the table or family to bail you out of sh-t happens is again not something one expects to hear from self-sufficient adults. I have had to help out family and while I would do it again, I found to be a very stressful thing to handle. Everyone has their own problems. Sh-t does happen, and no amount of hoping for the best or insurance policies will change that.

Keep in mind I gain nothing by you taking my advice. I'm sharing the benefit of my experience as well as what I've learned here in CMF and ultimately the only one who loses or gains is you. And your family.


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## hystat (Jun 18, 2010)

andrewf said:


> I guess I address financial risk not by having a large cash hoard to mitigate risk, but by being very careful about taking on the risk in the first place. I have no car payments, I have no mortgage. I have no student loans. If I lost my job, I could live for several years (rent + food and other essentials) on my current savings. I just don't bother keeping them in cash. I probably have a lot less financial stress than most people.


me too
and I can change my own oil pan, clutch slave cylinder, and patch the roof if it needs it
rare survival skills of a bygone era?... financial risks are lessened for the handy DIYer

for me, disability insurance is the big security because I can't do any of that with a broken back. 

I watched my sister's life turn upside down when she developed a couple of chronic issues and could no longer work.


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## Sherlock (Apr 18, 2010)

I want to know why it seems to be the general consensus on this forum that en emergency fund must be kept in cash?

To me, an emergency fund is anything I can liquidate within a few days. So even though I have almost no cash, my stocks, ETFs, REITs, and index mutual funds can be used to pay for any unexpected expense. Now there exists the risk that I will have some capital loss if I have to liquidate my equities in a market downturn, but I think this risk is worth it considering that the alternative would be to have my money in a savings account earning less than inflation.


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## Plugging Along (Jan 3, 2011)

I actually do not like having a lot of cash, and used to perfer having it invested. However, it seems like the most unlikely will all happen at the same time. My spouse who usually has about a dozen job offers EVERY month (more when the economy is good) got laid off, and couldn't get anything for 6 months. He actually had to go across the coast to the US to work. This was at the same time that my company which I was really really stable, and considered almost untouchable went through new management. I had never been worried about lay offs as I would have gotten over a year for a serverance (in fact I had asked for a lay off many times and been told no). They change the serverance to working notice (no severance just get to work). All at the same time, I decided to invest money that we were going to use to pay off the mortgage and use for mat leave over the next few years. Well, we lost 6 figures in our investments, and lost almost 50% on my emergency fund. I can tell you from personal experience when things are really down, and the impossible has happened, it is really really stressful to know that your investments may no longer be paper losses. Also, I have a really really good support system too for family, and they were calling informing us not to worry there would always be help. That made me feel worse and added more stress to my spouse because we have always been self sufficient.

Also, both my spouse and I have multiple streams of income, I do consulting with the government on top of my regular job. You would think that we would always have income coming in. 

I am actually really surprised that you or anyone would consider car repairs or home repairs as an emergency. To me, these are things that will eventually happen the question is when. I guess you would win if they happen after you have paid your mortgage off, and you would lose if they happen before you pay your mortgage off. I will be doing something similar. When we're at the point where we can pay off our mortgage off, then I will deplete the emergency fund. As soon as the mortgage is paid off, we will be immediately rebuilding our emergency fund, and be able to do it at a much faster rate, therefore our time at risk is relatively low. If I had 5 years before I would have an emergency fund, I would be concerned. 

I am curious how would you plan for lose of income. You said it would be easy. How would you plan for it if you had very little notice?


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## the-royal-mail (Dec 11, 2009)

Not sure if PA's questions are directed at me, but I try to promote the concept of 3-tiers of _savings_. Tier 1 is the true emergency fund as PA describes. The 3rd tier is for retirement, something that we can all plan for. Tier 2 is for things that happen on a regular basis but it's never really known when they happen. They're important, but not an emergency in the sense of a job loss or disability. For some people, a $4000 roofing job could qualify as an emergency. For others, that type of expenditure is considered house mtc. I don't consider brake repairs on my car to be an emergency but I do consider a broken oil pan as such.

The reason tiers 1 and 2 are separated is exactly for the reason PA outlined above. These sorts of things can and do crop up at the worst possible time, when the family breadwinner is already job-less and drawing upon tier 1 e funds. The idea is to avoid things like roof repairs from impacting tier 1 true e fund.

I also strongly feel that e funds need to be in cash, not invested in equities that are subject to market risk. The whole point of an e fund is to be there on a moment's notice when needed. That moment may occur, as PA described, when the value of your investments is down 50%.

Don't assume these things will never happen to you. If it turns out you're wrong, you'll be left out in the ocean without a life jacket!


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## Plugging Along (Jan 3, 2011)

TRM: I was actually asking the Maybe Later what he would do for loss of income, because he says it's easy (bolded in his quote). I actually do believe that the amount of emergency is dependant on your individual situation. For us, we have our operating funds which seems like a large amount because we have high expenses. We then have some cash, which we don't count as a tier 2, but this is for things that may come up including emergency, but it also has all the other things fund, such as repairs, trips, cars, etc. We don't see a reason to have a seperate fund, because we would have way too much in cash. For us it wouldn't take long to rebuild our funds, and we just cut discretionary spending if we spend a large chunk. I think how people structure their funds is really up to them. The key is to make sure they are able to cover if they lose income/get sick, etc, and to be able to cover the things that may come up. Ideally, not do it with debt. 




Maybe Later said:


> Funny you should mention kids. We have two, and if two pink lines yesterday morning are to be believed, a third on the way.
> 
> *
> Loss of income would be easy to plan for,* but extended medical costs for home care and the like? Getting pretty far from unexpected expenses for car and home repairs, but it is an interesting discussion. Thanks.


I missed the part of the pink lines. Congratulations. I would think this would reinforce the need for additional cash. I assume you would be taking a pay cut while your spouse takes some time off, unless she is already staying at home. Irregardless, babies even the third one can cost a little bit of money. 

Its only easy if you have notice or time to plan on it. I was curious how you manage a sudden lost of income while your spouse is on mat leave and a new baby. Don't think it can't happen. My spouse was give 1 week severance.


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## andrewf (Mar 1, 2010)

Plugging along, I say it would be easy because:

-I have a modest lifestyle. I can live on about $15,000 per year if I tighten my belt and cut out vacations, etc. I have no debts or other obligations beyond the above.
- I have several times that amount between my TFSA and RRSP.
- I have parents with the financial capability to help me out in the unlikely event the above two should be overwhelmed by the situation I find myself in.

My biggest concern right now is disability. I don't have disability insurance, and that is the only risk that really gives me pause. If I lose my job, I am confident I can find another. If I can't work, that would put a serious damper on my finances. So, I'm investigating disability insurance. I put this as a much higher priority than having a HISA with $50k cash in it.


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## Sherlock (Apr 18, 2010)

Let's say you have an emergency fund for 12 months of living expenses times $1500. That is 18k in your fund. If you have it in a savings account paying 2%, you are earning $360 a year on it. On the other hand if you had invested it in something returning 8%, you earn $1440 a year, a difference of $1080. So it costs $1080 a year to keep your emergency fund in a HISA instead of in equities. Is that $1080 greater than or less than the amount of capital loss you would absorb by being forced to liquidate your equities if you needed money when the market is down? Alternatively, is that $1080 greater than or less than the interest you would pay if you needed to borrow emergency money from a LOC? Even if I had to borrow $10,000 from my unsecured LOC at 6.5% interest it'd still be less than $1080.


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## the-royal-mail (Dec 11, 2009)

Sherlock, your entire argument is based upon an unrealistic assumption that the average person is capable of realizing consistent investment returns of 8%. I have never in my entire life realized those types of returns, despite my best efforts, nor do I know anyone (outside of some possible cracker jack CMF investors) who has. I don't really feel it's good advice to suggest that the average lurker and poster here is capable of those types of returns.

In fact, my TFSA, which is my tier 2 account, has lost approx 5% after I followed the investing advice I was given in CMF. That's in about 6 months. When I look at what the markets have done lately I don't believe I'm alone in that.


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## HaroldCrump (Jun 10, 2009)

Sherlock said:


> So it costs $1080 a year to keep your emergency fund in a HISA instead of in equities. Is that $1080 greater than or less than the amount of capital loss you would absorb by being forced to liquidate your equities if you needed money when the market is down? Alternatively, is that $1080 greater than or less than the interest you would pay if you needed to borrow emergency money from a LOC? Even if I had to borrow $10,000 from my unsecured LOC at 6.5% interest it'd still be less than $1080.


The answer, as usual, is _it depends_.
One of the primary factor that the answer depends on is : how secure is your job?
I think it is misleading to think of emergency savings as an "investment".
Think of it as an insurance, instead.
The moment you consider e-savings an investment, you start running into the opportunity cost and RoR concerns that you are expressing.
Whether or not e-savings should be kept in the form of HISA or equity investments (including REITs, income trusts, etc.), consider the following factors:

- What is the impact of a 40% drop in the value of your e-savings portfolio (if invested in equities)?
- What is the impact of a job loss _at the same time as a market crash_ : keep in mind that recessions/market downturns are often followed by mass lay offs across all sectors of the economy.
So unless you have a secure govt. job such as teacher, health care professional, etc. this is a valid scenario you must consider.
- What are your monthly/annual liabilities, including mortgage, kids' education, support to parents/grandparents etc.
- How fast can you find a comparable job in case of unemployment?
- How fast can you find _any_ job in case of unemployment?
- How generous is your disability/critical illness, un-employment coverage, taking into account all exclusions, terms and conditions?

Just some of the things to consider.
Regarding disability, critical illness, and/or en-employment insurance, keep in mind that they will often dump you in your hour of deepest need.
They will use any excuse, exclusion, fine print etc. to deny coverage.

Regarding using an LOC as a surrogate e-savings account, again keep in mind that the bank has every right to pull the plug when you need it most.

Try calling your banker and telling him : "hey Bob, thought I'd let you know that I got laid off yesterday. And BTW, I'm sure you know I am already running an overdraft on my chequing account. So my plan is to use the LOC you opened for me last year for running my expenses until I can find another job."

Even if your credit line is safe and the interest rate doesn't magically go up, the thought of running up a debt month after month is the last thing you need on your mind.
It is amazing how much debt you can run up in 6 months, and how long it takes to pay it all off after you get back on track.


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## Plugging Along (Jan 3, 2011)

andrewf said:


> Plugging along, I say it would be easy because:
> 
> -I have a modest lifestyle. I can live on about $15,000 per year if I tighten my belt and cut out vacations, etc. I have no debts or other obligations beyond the above.
> - I have several times that amount between my TFSA and RRSP.
> ...


In your case, you may not need much of an emergency fund. You do not have any debt, obligations or dependants. You're not going to lost much, other than your investments (if by chance you have to sell at a lose) if you need cash. 

I do think it's different when you have dependants (like 2 kids and a newborn on the way) and a mortgage. He not only starts at zero, but he could end up at less than zero. 





Sherlock said:


> Let's say you have an emergency fund for 12 months of living expenses times $1500. That is 18k in your fund. If you have it in a savings account paying 2%, you are earning $360 a year on it. On the other hand if you had invested it in something returning 8%, you earn $1440 a year, a difference of $1080. So it costs $1080 a year to keep your emergency fund in a HISA instead of in equities. Is that $1080 greater than or less than the amount of capital loss you would absorb by being forced to liquidate your equities if you needed money when the market is down? Alternatively, is that $1080 greater than or less than the interest you would pay if you needed to borrow emergency money from a LOC? Even if I had to borrow $10,000 from my unsecured LOC at 6.5% interest it'd still be less than $1080.


I am curious at where you can get a GAURENTEED investment of 8% per year. I understand average return. There is a chance that the year that you need the money because the economy is the craps, and because of that there are job layoffs, the investment could be down 40%. Your returns are based for any given snapshot in time. By the same argument, if you put 18K, and then at the end of the year, it's worth 10K, and then you need, plus now you are 8K short, and need to borrow at 6.5%. Your costs now are over 10K for the same amount. I think its a very one sided argument to just show the up side but not the downside. Again it's about the risk factor. You're trying to maximize the upside, and get the best benefit, but many risk people who do risks actually manage the downside, and that is a bigger concern. 

The other part that people don't seem to get about debt, is once you're in it, its very difficult to get out, it takes much longer to get out of debt than to get into debt. If let's say you can save 1000 a month, and you have use $10K for a minor emergency (which will take about a day to spend), it will take you 10 months to pay it off. Now, let's say in those ten months, another 'emergency happens' your car breaks down, and oops, another $3k, now you're looking at three more months. No one ever expects these cycles to happen, there's a reason, why bad news comes in threes. It's the whole compound effect. Why do you think there are so many people in debt. 

I was really surprised that only about 25% (in the US) people who were in debt it was because of consumer debt... the largest part was due to emergencies, and illness.


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## Maybe Later (Feb 19, 2011)

*Akkk!!!* I was unintentionally vague and then selectively quoted. Now I'm some kind of lunatic in rose colored glasses 

First of all, thank you for the congratulations - it is funny how it is "too early" to tell family and friends, but OK in an anonymous pseudonym online. Hey, a rooster's gotta crow!

What I _meant_ to convey is that when it comes to disability insurance it is relatively straightforward to determine how much insurance you need in order to cover the loss of income, since those are numbers you already know. Some individuals might also need to include any employer paid benefits that you will be responsible for. What I find difficult to determine is how much additional coverage, if any, one should have for increased medical or ling-term care costs.

In re-reading my post I can see where you would have come to a different understanding that I did NOT mean.

This sounds a lot like us:

_We don't see a reason to have a seperate fund, because we would have way too much in cash. For us it wouldn't take long to rebuild our funds, and we just cut discretionary spending if we spend a large chunk. I think how people structure their funds is really up to them. The key is to make sure they are able to cover if they lose income/get sick, etc, and to be able to cover the things that may come up. Ideally, not do it with debt. _

We just look at credit/equity/debt as a tool in the toolbox, which we have used to our advantage and ended up ahead. Part of it is our own personal situation - I have one of those secure teacher/health care type jobs. Harold makes some very good points, ones that everyone should consider.

@TRM - I'm probably not as young or naive as you seem to think. Just putting forward a different point of view. And, a lot of other pertinent details haven't been brought up.

It is academic in our own case becasue we are likely going to move, for lifestyle reasons - mostly commuting to the city as the kids get older and not having as much time around the acreage as I'd like to do acreagey things. We made that decision before deciding on trying for number three. It will likely have some financial benefits (country living can be expensive). But, we will also likely get to re-set the mortgage and/or emergency funds. Now is the time to think about them. New threads on the move for these in the future. 

Since I started the thread to get people thinking and talking about ideas.

Consider this: 

Tom, and Harry are brothers. They have the same house and the same job and are going to spend $2000 a month on servicing debt - both are making accelerated payments. Tom has built up an emergency fund of $50K, but in doing so, he is going to spend the next 182 months paying his house off. His money is in a HISA at 2% and after 182 months it is worth about $67,000

Harry has put that 50K against his mortgage, but can borrow it back, so his mortgage is 50K less. He is going to spend the same amount every month as Tom, but no emergency fund. His mortgage is paid off in 140 months. He's paranoid, so after his mortgage is paid he spends the next 42 months throwing the $2000 in a shoebox. When Tom pays off his mortgae, three and a half years later, Harry opens his shoebox and without any interest at all, there's $84,000 in it.

But suppose both of them have a $50,000 "emergency" after 3 years. 

Tom has the cash - pays it off. Now, he could save the extra 50K to get that emergency fund back, but it will mean cutting back on the accelerated mortgage payments and take 5 or 6 years. Or, he can still be done in 182 months with no emergency fund.

Harry borrows the $50,000 and pays it back out of the extra payments he has been making, still only $2,000 a month. After 5 1/2 years (68 months in my calculations) it is finally paid off - then he goes back to the $2,000 a month on the mortgage. He finds his mortgage is paid off in ... 182 months, the same as Tom.

So, assuming they can both manage their cash flow - and have reasonable access to credit - Tom is never ahead and if Harry needs any less than $50,000 ... he's done better by paying the mortgage sooner and then hiding the money under his bed.

Their brother Dick bought a $50,000 car and then had real problems in the emergency. Moral of the story ....

Yes, there are a lot of assumptions, such as interest rates don't change. In the schedules I ran they had fixed rate mortgages that never changed from 3.89%, Tom's savings grew by 2% compounded monthly and they had to pay 3.89% for the HELOC (I was going to run it at 3.5%, which is the going rate now, but for the sake of arguement, I kept it the same). Obviously, if the mortgage and savings interest were the same it would be closer to a wash, but I put up the numbers for people to consider. With a good variable rate mortgage today the spread isn't so large either, but if people can meet their obligations, then having a wall of cash might not matter. Sometimes it is as much about emotion and cash flow. Obviously emotion plays a big part - look at how frustrated this sort of suggestion gets people. Sleeping soundly at night is worth a lot.

I'm happy to continue the conversation, but not at the sake of generating real frustration.


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## Plugging Along (Jan 3, 2011)

It's an interesting scenario with a lot of assumptions. However, it is just one scenario. I would say that I could run enough scenarios where the other brother would come out ahead. 

I think you really need to look at your own risks, and see what happens. If you're putting money away in other forms, and you have money for when things like a new vehicle or roof come along without going into debt, then you are really the best to judge for your personal scenario. I don't think there is one answer for an emergency fund, I think the key is if people have a clear plan in how they will get/keep out of debt. 


It's all a matter of risk tolerance, and the impact and probability of certain events happening in your life. For me, I personally feel young kids add a whole new level of risk I never thought of before. Is there any chance that your wife will not return to work? How will that factor into the equation?

Like you said before, with you planning to move, then all of this is moot. I do think the thread is interesting for make those really look at where they may be putting themselves at risk if any.


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## Maybe Later (Feb 19, 2011)

Initially I thought it moot, but actually, the Tom, Dick & Harry scenario could be viewed as options for anyone moving, like us. It wasn't what I was thinking about when I made it up, but someone moving from one home to another - up, down or sideways, it doesn't matter - can choose to be either Tom or Harry.


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## dcaron (Jul 23, 2009)

Ive been considering a hybrid approach for EF/pre-payment. 

Ive been making bi-weekly advanced payment since the beginning of my mortgage term. 

Rather than the pre-payments, what if we choose to build a "pseudo" EF for 12 months at a time, then if no emergencies appeared in that timeframe, inject a lump sump mortage payment? 

A bit of stats about our situation: 
275K mortgage with 7 year fixed term @ 5.22% (we are approaching the 4 year mark).
We do not have a "liquid" EF.
We have $180K RSP with 15 year horizon (tier-3).
We have a prime rate HELOC, and two other unsecured LOC's. (potential tier-2)
We have no kids but planning for one in the short term.
My wife and I work in different fields.
I am the major income earner (2/3 of our combined).
We have plenty of unused TFSA room. (target for tier-1)

The "spread" cost of building up a yearly EF fund for now is 3.72% (derived from Mortgage Rate - HISA/ ING TFSA rate). I may opt for a riskier EF/investment portfolio, to reduce spread, but it probably makes more sense to aim for a lower risk EF, due to unknown horizon of event requiring pulling from EF.


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## the-royal-mail (Dec 11, 2009)

Hi dcaron, I understand what you are saying but the whole idea of an emergency fund is to stay out of debt and for it to be there no matter what. Your plan above relies on credit for tier 2. If it was that easy to just use credit, then there would be no need to even discuss this at all. Everyone would just use credit. Which is what's happening now and look at the mess everyone is in. People are maxed out and eventually come to CMF having "learned their lesson" and now have a huge mess to clean up. Paying off debt at high interest rates is no fun. That includes credit lines.

The point is to save cash during good times, so that it is there during the bad times. You are looking at a "cost" of building up this cash. That is the wrong approach. Tiers 1 and 2 must be in fluid cash, available to use on a moment's notice.

You should also not pay off your mortgage at the expense of a safety cushion. If you should ever be divorced and jobless, credit may be pulled out from under you and your cash may be the only thing that gives you money to function, get a new place to live, furniture etc. I suppose your idea could work IF you don't empty the entire cash savings after the 12 months. Set a goal to save say $30K, if you reach it after 12 mos then pay half down on the mortgage etc. But it's still risky. You'll need every penny of your e-fund if something bad happens. It won't do you any good in the mortgage where it's not accessible to use to buy food and keep the lights on.

Remember the tier 1 should have enough fluid cash to last you 6-12 months with no other income and no job, tier 1 is for larger unexpected and occasional things like new car, birth of a child, new roof repair, stuff that needs to be dealt with fairly early on.

You said you were just past the halfway mark of mortgage. 3 more years to go. A lot can happen in those three years. Don't be so concerned about the mortgage that you fail to establish a proper life raft flotation device in case you hit stormy waters.


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## dcaron (Jul 23, 2009)

TRM: Thank you very much for your insightful reply.



the-royal-mail said:


> Paying off debt at high interest rates is no fun. That includes credit lines.


My main HELOC has a rate of prime + 0.16%, but I realize that the prime will go up in the future (probably around the 2013 timeframe).



the-royal-mail said:


> The point is to save cash during good times, so that it is there during the bad times. You are looking at a "cost" of building up this cash. That is the wrong approach. Tiers 1 and 2 must be in fluid cash, available to use on a moment's notice.


Agreed, but non-registered investments in Self Directed brokerate account would be liquid, have low fees, and I would choose a fairly conservative allocation of various ETF's.



the-royal-mail said:


> You should also not pay off your mortgage at the expense of a safety cushion. If you should ever be divorced and jobless, credit may be pulled out from under you and your cash may be the only thing that gives you money to function, get a new place to live, furniture etc.


 Agreed. But all Im aiming for is making the minimun pre-payments to ensure Im mortgage free when I retire.



the-royal-mail said:


> I suppose your idea could work IF you don't empty the entire cash savings after the 12 months. Set a goal to save say $30K, if you reach it after 12 mos then pay half down on the mortgage etc. But it's still risky.


 That is a good compromise actually.



the-royal-mail said:


> You'll need every penny of your e-fund if something bad happens. It won't do you any good in the mortgage where it's not accessible to use to buy food and keep the lights on.


 This is specifically why I am reconsidering my approach, and reaching out for advice here.




the-royal-mail said:


> Remember the tier 1 should have enough fluid cash to last you 6-12 months with no other income and no job


Why are you not considering UIC in this calculation? A while ago, I actually did a projection of different scenarios for reduced income situations (one of us without income or reduced income, etc) I allways excluded UIC for the 1st month, and after expiration in 10 months. It does get rough after the 10th month mark when UIC runs out. I believe this is a more realistic projection than planning for no income at all from the get go.



the-royal-mail said:


> You said you were just past the halfway mark of mortgage. 3 more years to go. A lot can happen in those three years. Don't be so concerned about the mortgage that you fail to establish a proper life raft flotation device in case you hit stormy waters.


Agreed. I mainly mentioned this because after 5 years into this mortgage, I have the option of breaking this mortgage without the painful IRD penalty.


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## the-royal-mail (Dec 11, 2009)

Hi dcaron, excellent catch on the UIC point. I actually like to plan for 6-12 months NOT including UIC to offer maximum protection. For instance, what if tomorrow at work a devil of a manager comes in, or your dept redoes their processes and demotes you (for example) and makes it so unpallatable that you have to quit? You have to be careful how you leave a job. If UIC doesn't agree, you may not get any benefits at all. You may be without income (as you pointed out) for up to 4 weeks while they decide this or perhaps permantly. It happens to a lot of people who end us surprised. Sure, you may be saying now that things are fine and that it won't happen, but this whole efund discussion is to prevent against the unknown factors. Hope for the best, plan for the worst.

There's no harm in having too much cash on hand as you go through life.


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## andrewf (Mar 1, 2010)

The cash that is available to use on a moment's notice is the cash you have stuffed under your matress. Savings accounts don't count, as you typically have to wait a day to access.

I think needing tens of thousands of dollars in cash in case you need money in <24 h is, to say the least, an atypical level of risk-tolerance. I can't think of many situations that would require that kind of liquidity. Kidnap/ransom situations?


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## Addy (Mar 12, 2010)

Guigz said:


> To be fair, I did not sign it yet, I am still shopping around. But I will definitely ask to see the paperwork first.


Ask for a copy, then take it home and read it over for a few days then decide. I find reading that much wording in someone else's office I could never take it all in properly.

It's funny to tell a salesperson or relator or banker you'll take the contract home, read it over and get back to them. You can almost see their chin hit the floor.


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## houska (Feb 6, 2010)

I think the key is a) separating out volatility from true emergency, and b) being thoughtful about what liquidity lifelines your have, how diversified they are, and how long they would take to replenish. Whether you need a cash emergency fund depends on those answers.

In our situation, we keep enough cash around ("working capital") that we can handle the business as usual cash flow volatility. This includes planning for anticipatable but unpredictable events like car and house repairs, an unexpected trip to see ill relatives, delayed reimbursement of business travel expenses etc. This is not an "emergency fund" since these are not emergencies; it's just cash flow volatility. 

Second, we've considered having an emergency fund in cash or equivalents, but we've decided against it. We have enough other liquidity lifelines - investments inside and outside RRSP/TFSA, unused HELOC, family - that we are confident that we could financially withstand nearly any shock. One or other of these lifelines might fail, or be unexpectedly painful, e.g. HELOC is inaccessible, markets are 50% down (so a withdrawal is 2x as expensive), etc., but the likelihood of all of them failing is very small. If our total lifelines were the same ballpark as a reasonable (6-12) month expense cushion, we would have to be more cautious. But if the total lifelines have enough redundancy, it makes no sense to pay the negative premium of sub-market returns in return for yet more liquidity. (Of course, this is taking a long term view).


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## Maybe Later (Feb 19, 2011)

I think houska makes an excellent point and that the factors to be considered should also include cash flow. I am probably at fault for naming the thread "access to _credit_ rather than access to _equity_. There is a substantial difference. 

I think as a society we're comfortable with mortgage debt. If a person had $30 K of consumer debt many folks would be telling them to pay that down as quickly as possible, but many of the same people would not advocate paying down the mortgage as aggressively. 

I appreciate TRMs comments, but to use his categories I think we need to separare Tier 1 - loss of income, from Tier 2 - unexpected expenses (what I refered to earlier as the Oh Sh!t fund). People absolutely need to make sure they're comfortable with their income situation. However, in my opinion, the Tier 2 cash is highly dependent on cash flow. A $10,000 cushion for an individual who can allocate $100 a month to emergency savings is different than the same cushion for someone who can allocate $1000. For the latter person these may not be emergencies as houska pointed out. An equivalent emergency would be $100,000 .... who plans for that level of emergency? If I have that emergency as a risk, I'd better be insured against it.

Ironically, it's the latter group that pay an opportunity cost for having a pile of cash sitting around.

dcaron does not provide cash-flow details. Also, the amount of equity in the home and the ability to either build the cushion or react to an unexpected expense isn't provided, so I won't provide blanket advice. I'd say consider these in your decision. a 3.7% difference is significant, but needs to be well thought out.


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## andrewf (Mar 1, 2010)

^ If you mortgage rate were similar to most consumer debt interest rates, I would be arguing very strongly for mortgage repayment as priority 1.


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## dcaron (Jul 23, 2009)

Maybe Later said:


> dcaron does not provide cash-flow details. Also, the amount of equity in the home and the ability to either build the cushion or react to an unexpected expense isn't provided, so I won't provide blanket advice. I'd say consider these in your decision. a 3.7% difference is significant, but needs to be well thought out.


Equity in home is about 200K.
SDRSP: ~180K in couch potato allocation with 15 year horizon.
Employer Severance: ~ 6 months of regular pay (should this occur)
Years until retirement for major income earner: 15.
Cashflow after RRSP contribution and essential expenses paid: ~1k/month

Mortgage balance: 275K @ 5.22%.
HELOC balance: ~5K @ 3.16%.
Various Loans balance: ~4k @ 0%.
Credit Card balance: None - paid in full every month.

About a year ago, I projected several cashflow scenarios such as during reduced, or loss of income from one of the earners.


Scenario #1 - Loss of income from lower earner: We can afford to lose my wife's income, and still cover essential expenses. 

Scenario #2 - Loss of income from higher earner: We need full funding to cover for essential expenses for 1st month while the UIC kicks in. For months 2 to 10, we must fund a smaller amount. For months 11 and beyond UIC, we need full funding again. 

Scenario #3 - Reduced income for lower earner such as Maternity Leave: Similar to scenario #1.

Scenario #4 - Reduced income for higher earner due to sickness, Long Term Disability, change of jobs, etc): Similar to #2.

Scenario #5 - Reduced income for higher earner: Similar to #2.


The worst case scenario is #2, and that's the one I want to plan for. I know what I need for the first 12 months. Beyond this date, I would either accept any job, or keep looking or tap into my RSSP to survive. The marginal tax rate would not be as bad due to lower income, so I would be taxed less.


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## Maybe Later (Feb 19, 2011)

I think you've recognized you need that cushion against the loss or partial loss of income. After that, you may want to have a hard look at the reasons for the non-mortgage debt to see why you incurred it and carry it still. After that, I think it is a question of emotion. The math says pay the mortgage because it has the highest interest rate, but if a family debt at 0% is something you think about constantly, tackle it first. Also, consider whether those debts are necessary expenses under one of your situations. One point in favour of not having the HELOC if you have an income loss is that you don't have to pay the interest on it every month as an additional expense. 

A point I'll make in TRMs favor: if you think that you can handle a $10,000 unexpected expense with the HELOC, great. But if you had $10,000 squirreled away somewhere, now you can handle a $20,000 surprise. 

Comfort level matters a lot.


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## Spidey (May 11, 2009)

I guess part of the problem I have is envisaging a $10,000 emergency. My wife and I always only kept a couple of thousand as an emergency fund and poured everything else into the mortgage. We always figured if an emergency arose we could request to skip or reduce a mortgage payment or take a short term loan off our credit card. We never had to.


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## Maybe Later (Feb 19, 2011)

I'd feel very different about tapping the equity in my home at 3% compared to a credit card advance at 18%+. 

It might not have to be one emergency. In August we had a $3500 unexpected siding replacement right after we replaced a countertop ($6000, not an emergency, but unplanned). We could have easily had the furnace quit on us or something similar. We elected _not_ to reduce the accelerated mortgage payments since the interest carrying costs would be much less than a month's payment _and_ we were comfortable addressing the debt through cash flow. 

If I had to skip a regular mortgage payment, or borrow from a cc, I'd have an "unexpected expense" cushion.


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## dcaron (Jul 23, 2009)

Maybe Later said:


> ...you may want to have a hard look at the reasons for the non-mortgage debt to see why you incurred it and carry it still. After that, I think it is a question of emotion. The math says pay the mortgage because it has the highest interest rate, but if a family debt at 0% is something you think about constantly, tackle it first


 These were planned expenses, and we are expediting the payments to reduce impact on cashflow. Expect to pay these off in January 2012 once I get employer stock options exercised.



Maybe Later said:


> Also, consider whether those debts are necessary expenses under one of your situations. One point in favour of not having the HELOC if you have an income loss is that you don't have to pay the interest on it every month as an additional expense.


I will never close the HELOC, in case my EF is insufficient, or I opt to use the HELOC for leveraged investments in the future, once EF is established, etc.



Maybe Later said:


> A point I'll make in TRMs favor: if you think that you can handle a $10,000 unexpected expense with the HELOC, great. But if you had $10,000 squirreled away somewhere, now you can handle a $20,000 surprise.


I really want to move away from the bad habit of using the HELOC as an ATM, or credit card. I think a good way to avoid that is to plan for all predictable expenses (squirelling money away for specific projects).



Maybe Later said:


> Comfort level matters a lot.


Totally agree!


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## dcaron (Jul 23, 2009)

Spidey said:


> I guess part of the problem I have is envisaging a $10,000 emergency. My wife and I always only kept a couple of thousand as an emergency fund and poured everything else into the mortgage. We always figured if an emergency arose we could request to skip or reduce a mortgage payment or take a short term loan off our credit card. We never had to.


 That is a good approach if your mortgage provider allows skipping payments. Mine does not. Dont understand your rationale of falling back on credit card in times of stress or despair, unless your CC rate is exceptionnaly low, or better than your HELOC rate.


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## Maybe Later (Feb 19, 2011)

dcaron said:


> I will never close the HELOC, in case my EF is insufficient, or I opt to use the HELOC for leveraged investments in the future, once EF is established, etc.


My mistake for being unclear - my point was that carrying a balance on a HELOC just adds one more necessary expense (the interest charges, possibly principle depending on your credit line) compared to not carrying a balance should your income decrease. I wasn't advocating closing it.


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## Spidey (May 11, 2009)

dcaron said:


> That is a good approach if your mortgage provider allows skipping payments. Mine does not. Dont understand your rationale of falling back on credit card in times of stress or despair, unless your CC rate is exceptionnaly low, or better than your HELOC rate.


Good point. I should clarify by short-term, I mean really short term -- probably paid in the next month. Our mortgage did have a provision to miss a payment. (Come to think of it, we may have had to use that provision once.) I've always figured the best approach was to keep knocking down the debt. I didn't see the point of keeping a larger debt than necessary (eg. mortgage) in order to avoid a potential and unlikely debt. We had also bought a new house so were fairly confident that the furnace and roof would not be an issue for a decade or so.


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