You wouldn’t go skydiving without a parachute, or walk across a tightrope without a safety net, yet thousands of people buy homes in Canada each year without an emergency fund safely tucked away in the bank. When you take out a mortgage with no savings, you’re flirting with disaster. An unexpected job loss, drop in income, home repair, medical situation or divorce could spring up out of nowhere, causing you irreversible financial strife. No one every expects this kind of misfortune, but that doesn’t mean you shouldn’t prepare for it. It’s always better to be safe than sorry, especially when it comes to your finances. A cushion of at least three months living expenses is just the start.
Are Your Ready for the Unexpected?
A survey by CIBC on contingency funds has found that close to 40 percent of Canadians with low mortgage rates have no emergency savings. What’s worse, a large percentage of these homeowners don’t have the ability to borrow any additional funds. For these financially-maxed folks, an unexpected expense of $5,000 could easily put them at risk of not being able to manage their mortgage payment.
When times get tough, these cash-strapped individuals will often resort to cash advances from their credit cards, turn to family or friends for a loan, or borrow from a line of credit in order to make ends meet. Unfortunately, none of these options are a suitable source of emergency income.
Is a Line of Credit A Contingency Plan?
The most popular source of emergency funding for Canadian homeowners nowadays is a home equity line of credit (HELOC). According to the Canadian Association of Accredited Mortgage Professionals, approximately 34 percent of mortgage holders also have a HELOC. For many homeowners, this actually makes sense. This is because mortgage prepayments provide a better after-tax return than virtually any savings account, especially those with low 1 or 2 percent return rates. Low rates on HELOCs make borrowing less costly.
Interest in HELOCs has increased by roughly 170 percent since 2001, but it’s worth noting that this credit source isn’t right for everyone. Remember, you need a down payment of 20 percent to secure one (an unsecured credit line could be an alternative for some homeowners), and you’ll need the fiscal self-control not to blow your new cash source on unnecessary purchases.
So, what should you do if you can’t afford a HELOC? If tying down 20 percent equity is impossible, common sense says you’ll need to save the old fashioned way. Whether you have access to a HELOC or not, you should always aim to have at least three months of living expenses stashed in a savings account. This money is for emergency expenses only – and no, a new television is not considered an emergency. If ever you do need to tap this resource, remember to replenish it as soon as you are in a position to do so.
While a large cushion of cash is somewhat less critical for qualified borrowers with a stable job, low debt-to-income, and reasonable mortgage payments, it’s still worth making the effort to put away an emergency fund.
So, should you wait to buy and reinforce your savings first? The simple answer is yes. The risk of being priced out of the market right now is extremely low. The Bank of Canada has committed to keeping rates low and international economic pressures are only adding to the urgency of this decision. There’s no urgency to buy, so be smart. Build up your emergency fund before you secure a best rate mortgage and enter the real estate market.