Ask The Readers: Cash Savings vs. Paying Down Loans

There was a great response to my last Ask The Readers post: Parents Losing Home To Foreclosure!, so here’s another interesting question from one reader who’d like the input from other readers (yes, you!). It a variation of the old saving vs. paying down debt debate:

My wife and I were having a debate about savings as it relates to our home equity line of credit (HELOC). She has been brought up under the mantra of “always have at least 3 months of savings available,” which is fine by me, since I’ve always been a saver. Prior to getting the HELOC, we saw eye to eye pretty well. Now that we have a HELOC with about a $20k balance on it, I no longer would like to put any of my extra funds into a conventional “savings” account, but would rather use it to pay down the balance on the HELOC. To me, this is a game of interest rates — the HELOC is at 3.99% and the savings account is about 1%. I’m an IT guy who likes to see things in black-and-white whenever possible, and this is a case of that. As such, I’m willing to keep a ZERO (or negligible) balance in my savings account and just transfer funds from the HELOC account whenever we need money. I’m having a hard time selling her on this idea, though.

As I see it, I’d rather have $0 in my savings account and and $11k balance on my HELOC, whereas she’d rather have $9k in savings and a $20k balance on the HELOC. Even discounting the tax advantages of a HELOC, it seems like the higher interest rate accrued on the HELOC debt should override the low interest on savings. To me, it’s all one pot of money with differing interest rates. What’s your take? I’m sure this isn’t an uncommon circumstance.

The Liquidity Factor

This doesn’t directly answer the question, but I felt like one missing consideration is liquidity. Are home values decreasing in your area? How much home equity do you currently have? Unless it is a very high number, you may be in danger of having your HELOC frozen by your bank, which means you could be unable to borrow any more money at 3.99%. Many banks have been doing this recently.

If you were in the $0 in savings and $11k balance scenario and needed $1,000 to fix the car or more for some other emergency, what would you do without the HELOC? I am guessing that this is the situation that might worry your spouse, it would worry me!

Readers, what would you do?

Comments

  1. If there were 0 risk of the bank freezing your heloc, I would completely agree. But in this case I would hedge my best and placate my wife by meeting half way – Half the extra into savings and half into the heloc.

    Mike

  2. Steve Bonds says:

    First of all– keep your spouse happy. :-)

    The question I would ask is– how much savings do you need in order to feel comfortable should the bank decide to freeze your HELOC? Since your house value is already under your mortgage balance (based on your ongoing net work calculations) I think you’re at a higher risk for a bank freeze than someone who was at an 80% loan-to-value.

    I think zero savings would be too risky versus the small gain you’ll be getting.

    — Steve

  3. Whichever makes life easier with your wife! We are only talking $270 a year. Now $270 would be a nice amount to pocket but it might not be worth the trouble it could cause. But, you do need to be pay some principal down on your HELOC. If yours is like mine, then you are only paying interest every month. Personally, I’m paying towards my HELOC and it’s at a 3.25% rate. I’m not worried about my HELOC being frozen, we bank at a small community bank.

  4. Yes, I agree with PPs because that $270 certainly isn’t worth getting stressed out over. Having a little cashola in your bank account is definitely a comfort worth paying for — especially in this economy. From a pure percentage point of view, of course, you are right, but we are talking about feelings, which is very hard to measure.

    The HELOC is valuable too, and I would think paying it off might also cause your bank to perhaps close the line faster. After all, if they are not making money on you, they might as well have that amount of credit available to another customer.

  5. I’ve spent my life paying down debt instead of saving. Now I have debt only on my home and one car plus a commercial building that houses my business.

    Now that I am middle aged I wish I’d done a little less borrowing and a lot more saving. I hope this is of some help.

  6. “Compromise”

    If I could do that a lot better, I may not still be single. :) But maybe you two can “compromise.”

    You want to move all the savings, and she wants to keep building the savings. What if you just hold the savings where it is and just work on paying down the HELOC from now on and resume saving more after the HELOC is payed off? Or find some other happy-medium of lowering your savings contributions and adding to the HELOC payments. This way you still have some liquid savings, but are still paying down the HELOC a little faster. And you are happier for paying it down faster and she is happy to still have cash in savings.

  7. This ties in heavily to what Jonathan mentioned in the last paragraph.
    I think what really has to be factored in is the fact that you’re putting your savings with a third party (the bank with the HELOC) that can do whatever they want with it. At least in the savings accounts, it’s (hopefully) FDIC insured, so you could have a 24 hour problem, but that’s the extent of it. They could have signed paperwork freezing the HELOC this morning at 9AM and you wouldn’t have the slightest clue until it comes in the mail.
    Always have cash in the bank PERIOD. Not stocks, not CDs, you want cash. I don’t care if you have credit card debt, mortgage, owe your friends money, etc. You have to have cash that you can get to.
    One possible problem could be the right of offsets if the accounts are with the same entity (ie, your cash balance gets hit to pay off the HELOC without advising you. Most banks include this with paperwork you sign for HELOCs, LOCs, sometimes even credit cards. Which is why you always want two banks involved in your personal finances.)
    Even if home values are SOARING in your area, go with the cash. Don’t let other people control your savings. Well, besides your wife…

  8. Slightly different scenario, but we are also big fans of saving, and at the same time have about $52k of student loan debt. We are struggling with the psychological (not to mention liquidity) implications of stockpiling cold hard cash, even at a pathetic interest rate, vs. the desire to pay down the loans as quickly as possible to minimize interest paid over time.

    We’ve currently balancing the two – accelerating payments on the loans, but still continuing to save. I too love a good cost-benefit analysis, and I know that the numbers would tell us to pay the loans down even faster while saving less, but psychologically I just want that cash in my savings account.

  9. My own view is that 3 months of cash on hand is the absolute minimum for unexpected liquidity needs, so I’d keep the savings. If health or vehicle emergencies arise one may end up paying even more interest. We keep way more than 3 months of cash on hand (I think 4-6 months is reasonable), but under some circumstances I’d spend down to 3 months worth. Cash is worth a lot more than the promises made by some bank (and that may well have been a foolish promise).

  10. I wouldn’t trust that the HELOC will always be there. Banks have been playing a lot of dirty pool lately with lines of credit.

  11. In my situation, I was more comfortable having cash on hand. I was able to find a reward checking account that made the difference negligible. I kept a large emergency reserve until I was able to pay off the entire balance, and then I did dip into the reserve a little, knowing that I would quickly be able to replenish it since I didn’t have that payment anymore.

  12. Given both sides, I would just say go halfway and put half the cash towards teh HELOC, and leave half in savings. Then, put some of each paycheck into savings and some into the HELOC to pay it down while maintaining the cash cushion. The chance the bank will close the HELOC does exist, but the chance your spouse resents you exists as well.

    A more interesting question to me is, why do you have a HELOC with 20k on it and only 9k in savings? What was so important that you had to spend that 20k on?

  13. Cash is King, baby! Your HELOC rate could change, or your line could freeze, or the bank could go under, etc.

    With cash, you are in control of your own finances and destiny. With credit, someone else is controlling your life.

    -Billy

  14. I was nearly maxed out on my HELOC (due to home improvements), when I got a windfall of cash and decided to pay down my HELOC by $25,000. My theory was this: I could draw on my HELOC if I needed the money. Well, guess what! 4 months later, the bank decided to reduce my available line right down to the amount I owed on it. My perfect payment history, my perfect credit, and my 20 years with the same bank didn’t matter. The bank said that property values had fallen so much that they were going to mitigate their risk. Oh, I had no savings whatsoever. I don’t like the feeling of having only high-interest credit cards to back me up if I’m short on cash. Now, I’m building up my savings account and making the minimum payment on my HELOC until I’ve built up a 3-month cash reserve.

    I suggest a compromise for you. Pay a little extra to the HELOC and build a cash reserve. You just never know when the bank will decide they don’t want you to have access to their money any more.

  15. I used to think the same way. I had $100k in HELOC and other lines of credit and didn’t keep a cash reserve. Well, last year several banks all decided that at once (several different properties) that my properties were worth less then the HELOC and cut off all of my HELOC.

    Don’t depend on your HELOC for emergencies – get an emergency fund

  16. I hate having extra debt around, but I would still leave the 9k in savings. The extra $270 a year is just not worth the risk of losing all access to liquid cash. However, I would probably stop putting more in to savings until I had the HELOC paid off. You could also look at moving your emergency fund to a rewards checking account. I currently have one that pays 4.11% APY on the first $25,000. Look for other ways to reduce your expenses or increase your income and get this thing paid off faster. That’s a large debt to have with only 9k in savings.

  17. I’d keep the 3 months savings in cash. Anything over that put towards the HELOC, but keep the 3 months buffer in liquid cash.

    As has been pointed out, the bank can suspend or freeze a HELOC if they want to. That line of credit is not guaranteed and is only available at the whim of the bank.

    Having the cash in the bank may help make your wife feel more secure and at ease.

  18. A/Aa/Aaa muni bonds will get you insured money at better and possibly tax deductible interest that is higher than 3.99%. If you have a 4% bond paying tax free through both the state and the feds, that would be like having anywhere from a 5-9% taxable yield and would make both you and your wife happy.

  19. As has been said before, that HELOC is not liquid because it can be frozen at any time. This happened to me with almost disasterous consequences.

    What you should do is open a rewards checking account paying 4.5% to 6% and put your cash savings in there. It is liquid, FDIC insured and paying a higher interest rate than what your HELOC is charging you. Hopefully the interest can offset and you can pay down your HELOC with an extra $100 to $200 a month. This would be a compromise that makes you both happy.

  20. Cash, to me, is king. Save it for a rainy day.

  21. While I agree with all the other posters I just wanted to say that I understand how you feel. Having money sitting around when I could be maxing out my Roth for the year or paying off my car loan early is very hard to do psychologically.

  22. Ken in Georgia says:

    My wife and I are dealing with a similar issue in deciding if we should leave cash in our pathetically low rate money market account or make large lump sum payments on our HELOC. My wife has survived several rounds of layoffs at her organization, but the future is still uncertain. Consequently, we feel it’s a good thing to have a lot of cash on hand. Personally I feel the 3 to 6 month rule is now obsolete; a year or more is prudent for the times we live in. Anyway we reached a compromise in that when our money market account hits a certain balance level, we make a signifcant payment on our HELOC, but not letting the MMA drop below a certain minimum — sort of a best of both worlds approach.

  23. As the person who asked the original question, I guess it simply boils down to the risk that the credit line will be frozen. I don’t fully know the reason that this happens, how much warning the bank would give me, or what would happen to the unpaid balance. I could literally swap money instantaneously between the HELOC account and a savings account, so unless they freeze it instantaneously without warning me, it’s really a non-issue to me. This is fundamentally different from paying down, say, a student loan or car loan, because you can’t tap into that money again if you need to.

    Thanks to everyone for the feedback. I shouldn’t have framed this as a marital disagreement, since I wasn’t looking for marital advice ;). I really just wanted to understand the pros and cons of doing it one way versus doing it another, and the numbers I used were for example purposes only.

  24. One more comment I forgot to mention…house prices in my area are stable and/or rising, and I have plenty of equity in the home. Not sure how this affects the likelihood of them freezing the credit line. Also, it’s with a highly-respected local credit union, rather than a big for-profit corporate bank. They treat their customers as real people, and I doubt that would change anytime soon.

  25. My answer is “it depends”

    You mentioned your savings rate vs your HELOC rate and this is important, however your savings rate seems very low to me – that is what you should address first…

    Assuming your HELOC rate is well above your savings rate:
    If your LTV on the property backing the HELOC is lower than 80, your HELOC should be very safe. In that situation I’d paydown the HELOC and consider the HELOC your “emergency fund”.

    However, if there is any reason to believe your HELOC could be “frozen” then it makes a lot of sense to carry a balance and keep cash in a Savings Account (or CD).

    If your rates are close between savings and HELOC:
    I’d keep the money in savings, you wouldn’t be losing much interest-wise and they money would be completely under your control.

  26. I vote for keeping enough money in savings so that you have a cushion in an emergency. Opinions vary on how many months income to cover. I’d be happy with 3 months.

  27. Adam, the bank has to have good reason for freezing your HELOC. They can do it and then notify you so it would be to late to transfer any money. The unpaid balance would stay there unless you had some sort of demand payment clause in your note.

    IMO, your HELOC won’t be frozen for all the reasons you listed. I would be curious to know how many readers have had their HELOCs frozen by big banks compared to small banks. And you’re correct, it is fundamentally different than other loans, I’d pay away.

  28. In response to paying off the HELOC and having zero savings….Is your HELOC your only monthly expense? If not, you shouldnt pay it off and leave yourself no savings. If you lose your job it would be easier making monthly payments from savings than having no HELOC debit and no savings to pay other bills.

    Always keep a emergency fund and use extra money from that to pay down your HELOC. Maybe keep the emergency fund in a ROTH IRA if you dont like the zero return on savings accounts.

    With such a low interest rate 3.99 that is cheap money, so pay it off slow. This advice is not 100% sinceI dont know your situation, if you already have a large ROTH IRA than pay off the heloc and use your ROTH as an emergency (as you can withdrawl the pricipal without penelty)

  29. I’m with you on this one, but to a point. You need to know your own situation. For me, I know I have pretty much 100% job security unless I molest a kid or something. So I keep a few thousand liquid, but I know I can save an extra thousand a month quickly if I had to for some sort of emergency. You should just consider what would happen in the unlikely event you had zero access to the HELOC. Can you borrow money from your ROTH? Can you save money quickly? Do you have a plan? If you do, then put your money where it’s working best for you.
    However $9000 really isn’t that much to have liquid though. Given there doesn’t seem to be 100% access to HELOC’s as others mentioned, it’s not exactly the same money. I think a good idea for couples is that when 2 people disagree you should take the more conservative approach (within reason) which in this case would indicate siding with her. Maybe you could offer to buy her something nice with the money saved if she agrees to keep more of it in the HELOC though?

  30. “Billy” and “Patrick” said it best. Cash is king!! I’d much rather have the money in the bank. Helocs, especially these days with falling home values, are not guaranteed.

    Say it loud, say it proud…CASH IS KING!!!!

  31. I think people have made the point the the bank controls your HELOC and you control your money. This could be a great arguement never to pay off your house.
    So I’m wondering, how did you end up with the $20k HELOC? Do you actually have extra money left over at the end of the month? If you do I’d be even more confused with how you ended up with the HELOC.

  32. Another aspect is your longer term goals. It sounds like your near term goal to keep $0 cash and a Heloc balance might also turn into your long term practice. You didn’t talk about how you might get to a $0 Heloc balance and 3 months cash. Traditional investment advice is to keep three months cash (or cash equivalent) and then start investing. If you never have cash, you’ll never be able to make investments outside your employer sponsored retirement plan. They talk about the 3 legs of the retirement stool (it is actually 4 for many people), Social Security, Company sponsored retirement plan (if any), and personal savings (with the 4th for many is working). Or you can be like one quarter of those retired and only live off Social Security, ack!

  33. Not much to add. Listen to the other posters and keep your savings for all of the reasons they state.

  34. I’m a little surprised at all the advice saying to keep money in savings. What if the HELOC was at 10% and savings accounts are at 1%? I also don’t see any difference between a savings account and a HELOC, aside from the interest rate differences. A HELOC is nothing more than a liquidated fraction of your housing equity. Money put into savings is money not put toward paying down your house. The size of the pie remains the same. If you have money sitting around, it seems best to have it offsetting relatively high interest rates in a HELOC rather than earning relatively low interest rates in a savings account. The liquidity is exactly the same, and the money could be swapped between accounts much like between a checking and savings account. I just think that we’ve been brainwashed into thinking “savings” only means a savings account, where more broadly, it means “accessible money”.

    Also, to those who don’t understand having a $20k HELOC balance and a < $9k savings balance, it’s not really all that unusual. It’s very much like an auto loan, except you can re-borrow that money that you paid back if you need to. It doesn’t seem finanically irresponsible to me (the implication from those asking about it).

  35. Adam-
    You seem to think that HELOCs are guaranteed to be available…nothing could be further from the truth. Banks yank HELOCs all the time and there’s typically nothing that can be done except applying for a new HELOC at a new bank.
    And I don’t care if the HELOC is at 20% and cash earns zero. Cash rules all, and you have to have some squirreled away. All other loans, credit cards, etc can be closed at a moment’s notice. It’s happened to me, happened to clients, and happened to people on this thread. It’ll eventually happen to you, too, but hopefully it won’t cause a problem.

  36. The banks can and do change the available options (read:HELOC). As many others have stated what if your HELOC is no longer available. Or here is another one, what if the day you need your HELOC is the day the FDIC takes over your bank and freezes all new credit? Nah, that never happens ;) I have personally counseled individuals that had everything under control and all of the sudden well, things changed.

    “Past performance does not guarantee future results.”

  37. Adam, I agree with you. You stated you are with a local credit union, plenty of home equity, and steady or rising home values. Just because people’s HELOCs got revoked in Arizona, Florida, Nevada, California, etc, doesn’t mean that’s the norm across the country. Everyone’s situation is a little different. If you have a good relationship with your bank and lender, you will be fine.

  38. I guess the important takeaway is the obvious — not to put all your eggs in one basket. Suffice it to say that a savings account and a HELOC are not my only two sources of easily liquidated money. My financial strategy is actually very conservative (the 4% HELOC loan is actually my highest interest debt, including my mortgage), and so I always make it a point to have backup plans, even though savings accounts are the least efficient kind of backup, in my opinion. If it’s $270/year that I save, that’s still a fair amount of money to me.

    Once again, I thank everyone for the feedback. This is my first time posting here, and it’s nice to hear other people’s opinions on such a controverisal topic, even when they are very different from my own. Clearly some people (in this forum and beyond) have been bitten by being overleveraged, so I am very careful to avoid crossing that line.

  39. I would put money into the savings account. DON’T rely on a HELOC for anything. The account can be frozen and then you are left with no savings and no HELOC.

    This is exactly what happened to me. Luckily it was 2+ years ago. I always maintained a small savings account, I mean small, like $1K, and relied on the HELOC (not counting 401K’s and IRA’s). It was with INDYMAC, which out of the blue froze all their HELOC’s shortly before going under. Since then I’ve accumulated almost $17K in savings and sleep so much better at night……… Get the safety net strung out underneath you and family first, and don’t ever trust the HELOC. Pay it off over time, the spreads minimal at this point, and it is tax deductible, if that makes you feel better about it.

  40. One thing I should add is when my IndyMac HELOC was frozen, I had a 760 credit score, no late Payments to INDYMAC, nor any other creditor. When I spoke with INDYMAC on the phone they didn’t give a hoot about it. It was frozen and that was that- and it’s still frozen. The interest is 2.5%, with my ING savings at 1.39%, I figure the HELOC is tax deductible and it is a wash. I am going to refi it and lock in a rate, since I think inflations going to hit us hard soon.

  41. Adam said: “unless they freeze it instantaneously without warning me”

    No there would not be any warning. If they gave people warnings then the irresponsible people would just borrow piles of money on the HELOC before the freeze.

    Adam said: “Suffice it to say that a savings account and a HELOC are not my only two sources of easily liquidated money.”

    Thats a detail we didn’t get in the original question. How much money is it? What form is that money in? Stocks, bonds, something else?

  42. Jim,

    Point taken about the freezing of credit.

    It is not really relevant what other sources of liquid funds I have available to me (let’s imagine I have a rich relative who would bail me out in a pinch), since that doesn’t change the answer to whether money is better stored in savings account or used to pay down a HELOC balance, does it? If your answer was going to be, “If you have enough money in some other liquid investment, it’s OK to pay down the HELOC,” then you’re basically saying that savings accounts are a poor choice for where to put money…which was my original point.

  43. We’re in the same boat. We have a 200,000 HELOC. We’ve used it quite a bit for two capital improvements on the house. It got as high as 70k 3 1/2 yrs ago, we got it down to 13k last month.

    We do save monthly into tax-advantaged accounts like (401ks and 529s). We also save a little monthly toward yearly high bills (property taxes, insurance, etc.). But we don’t save toward an un-taxed advantaged, low-interest bearing, emergency fund.

    I personally can bear paying $70 per month in interest on the HELOC, while getting paid $10 on my savings.

    It might be an interesting exercise to make a spreadsheet taking a fixed amount to be paid down on a HELOC and taking a monthly amount to be “saved” vs “paid” and compare which winds up being the winner after x months.

  44. Adam,

    I think you are very wrong in using the argument of having a rich relative to bail you out and not having that make a difference in the argument of savings or paying the heloc being better. The argument is not as simple as ‘which produces better returns’. If it were that simple than the winner is clearly pay off the heloc because that is essesntially a gauranteed 3.99% return that you wont pay in interest.

    The argument is more of a pay of heloc or save and have money to pay the heloc payments and other bills in case of an emergency. I would keep a savings that way if disastor strikes I can continue to atleast make the minimum payments on my bills (utilities, fixed expenses, variable etc).

    You throw in the rich relative element and I would catagorize that as an ‘invisisble and emergency savings account’. Go pay off your heloc and if disator stikes you can hit up your relative to bail you out. Not the most dignified way but hey you’ll be out of debt as long as disator doesn’t strike.

  45. A savings account is the best place to store an emergency fund, but the worst place in terms of returns. But, you need an emergency fund, especially in today’s economy. That’s my opinion.

    This may be an ignorant question, but isn’t the rule of thumb to pay off the highest rate of interest first? And, wouldn’t the mortgage rate be higher than the HELCO (only 3.99%). By that logic, shouldn’t he pay off the mortgage early? Am I missing something fundamental? If “it’s all one pot of money with differing interest rates,” shouldn’t he attack the highest interest rates first?

    (Maybe he doesn’t have a mortgage, or maybe the mortgage rate is lower than the HELCO?)

  46. Noj,

    I do have a mortgage, and currently it is below 3.99%, but there’s a major difference between paying down a mortgage (or student loan, auto loan, etc.) and paying down a HELOC, since you could easily borrow that money back from a HELOC while you can’t with those other types of loans. That was really the essence of my question.

  47. It’s interesting to note so many people suggesting the cash route or at the very least a compromise of some of both.

    While traditionally people have done too little saving AND too little of paying down debt, there is psychological value in having cash in the bank that seems intangible but can actually contribute greatly to future wealth.

    I’m not sure how to put this, but you go about your day differently when you have cash reserves – it eases the mental pressure of the debt and the worries. Unless you can pay off your debt entirely with cash on hand, that cash has value as a catalyst for better feelings and better actions with respect to money. You may find better ways to invest it and make to grow — for instance, just knowing you have the money on hand for a financial opportunity will make you more apt to LOOK for financial opportunities, where you would not have if you were focused on paying down debt at the cost of all else.

    Even if you are paying high interest rates on debt, the old ‘pay yourself first’ can have a remarkably positive effect on your psyche – and your future wealth, despite the debt.

    Cheers, and here’s to sound financial health for us all.

  48. Noj said it simplest: “A savings account is the best place to store an emergency fund, but the worst place in terms of returns. But, you need an emergency fund, especially in today’s economy.”

    The real question here seemed to be, “Is it ok to use a HELOC as my sole emergency fund?” If your low-interest savings account is not your only current option for an emergency fund, then you have not disclosed all relevant information. Basically, you should not use the HELOC as your only liquid emergency option, but if you have stocks, bonds, mutual funds, an IRA you’re willing to take a penalty on, a wealthy and benevolent relative, etc as other options, then keeping the basic savings account around isn’t so critical, is it?

  49. I know that to have even a low interest loan all paid off is desirable, but to have little to no savings is not a smart move for anyone to make in these uncertain times. You mentioned that you were an IT professional, in that case you should consider that more and more company’s are laying off workers and offshoring more of this type of work. If you were to get layed off, and after a few month severence the only thing you would have besides your spouces income (if any) would be unemployment benefits which would barely cover your bills while you looked for work. There is a reason that people have money in savings accounts with little or no interest and that is to be able to get at it if they need it.

  50. Keep the savings — keep putting into savings and pay off the HELOC by selling things and putting extra money that you can against it. Make it a mission. If you ever want to purchase an asset, you will need to show a dedication to saving. Pay yourself first — always and you will be far better off down the road.

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