This week we’ve got a question from a listener, Dean asks: “What are the pros and cons of using your emergency fund to offset your home mortgage (in either an offset or revolving credit facility)?
The background to this is that my wife and I have managed to save an emergency fund of ~$50K but also have a mortgage of ~$800K. At the moment we are trying to workout where to “store” the emergency fund and our current thinking is that we might just pop it in a regular savings account in a bank that is not our main back.
Appreciate that you can’t give personalised financial advice on the podcast however thought it might be interesting to hear your thoughts in a general sense. Keep up the good work – I look forward to the podcast coming out each Monday!”
What is an emergency fund?
An emergency fund is a financial safety net for future mishaps and/or unexpected expenses. It protects you and your financial goals from life’s curveballs. Usually it consists of 3 – 6 months worth of expenses depending on your situation. We recommend an emergency fund as one of the first steps of our financial plans.
What are emergency funds used for?
Not for Friday drinks, or upgrading the TV. It is for true emergencies, this might be if your car breaks down, or your laptop breaks and you need a new one, or maybe a family member gets sick and you need to travel overseas to see them. An emergency fund is to ensure that no matter what happens, you don’t end up financially worse off because of it. It protects your saving goals, your investments and stress levels when unfortunate life events happens.
It also stops you from relying on credit cards or high interest debt for any unforeseen circumstances. Which can be hard situations to get out of once started.
Where should it be stored?
There are 2 places that you could store an emergency fund, our methodology behind a safe place to store an emergency fund is that it has to meet 3 requirements; it’s available, it’s liquid and it’s safe.
Savings Account
Our solution for most of our clients is to have their emergency fund stored in a savings account. Depending on your spending behaviour, this can be at your main bank, or a seperate one so you’re not tempted to dip into it on a Friday night. While the interest gained might be negligible, it’s always available and liquid.
Offset Facility
For people who are extremely good with their money habits (and have a mortgage), they may choose to store their emergency fund in an offset facility.
How it works: the money in your eligible savings and everyday accounts all work to help you pay off your mortgage faster. You only pay interest on the difference between what’s in those accounts and the balance of your mortgage (this means you won’t receive interest on the linked savings accounts).
A revolving credit facility serves a similar purpose and poses the same risks as the above.
You should always chat to your financial adviser and mortgage adviser to see if this is right for you.
Some considerations
Using an offset and saving on interest costs might sound appealing but remember, when you do have to use the emergency money, you will be charged floating market rate interest costs at the time, this could be significantly more (or less) than your fixed interest rate.
For many, keeping things simple is the way to go, by keeping their emergency fund in a simple savings account means not mixing up the purpose for the money and knowing that when things do go wrong, there’s no added cost to using the money.
Conclusion
It’s always best to speak to a financial advisor before making these decisions so you have a good understanding of the potential benefits and costs.
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