I've heard the principle of "Pay yourself first", implying that saving some money each month should be a priority. However, I've also heard that being debt free is important, and it would be good not to lose income to the interest payment on the loan. In general, we're trying to get to a savings cushion by setting some money aside each month. But we are also trying to pay off a HELOC so that we are not throwing away money on interest. If we did have a financial crisis, we could draw more from our home equity line of credit. In prioritizing where the money goes each month, is funding the savings account more important than paying off the HELOC as soon as possible?
Emergency fund first. Period.
The interest you pay on the HELOC until you have the emergency savings fund is like buying insurance. It's an expense you incur until you can afford to bear the risk yourself (here the risk is of a personal liquidity crisis). When you have enough in your emergency fund to be comfortable, start using whatever amount you were putting into savings to pay down the HELOC.
Alex B is right that paying off the HELOC is a guaranteed return, but your emergency fund is not an investment -- it's your safety net.
I would prioritize paying off the heloc first. Paying off the heloc has a guaranteed rate of return and will reduce the size of savings cushion you'll need in the future.
However, you shouldn't assume your heloc funds will remain available indefinitely. If you read your fine print, you are not guaranteed access to your unused credit by the bank. If you lose your job or your home value significantly declines, the bank could refuse to let you take more money out on your heloc. Recently, I've seen people's available credit be reset to 0 on open helocs by banks trying to reduce their exposure. Planning on the future of available credit via a heloc is not a good safety net.
Based on your situation, I'm not sure it should be an either/or sort of choice. The less debt you have the better, but because the HELOC is secured debt, the interest rate should be rather low. If you're trying to build a cash cushion for emergencies, it may help to figure out a few things first:
- How large a cash cushion do you want? (3 months living expenses, 6 months, more)
- When do you want to have this cushion accumulated by?
Once you know how much you want to save and how long it will take, you can figure out how much longer it would take of some of the savings were diverted to debt reduction.
If your credit is good enough to get a HELOC in the first place, putting some of your cash-flow toward both goals is an option worth considering.
Dave Ramsey says you need to have at least $1000 in savings. The philosophy is that any typical emergency will cost you $1000 or less. Let me tell you - this has saved me more than once. Savings account is very liquid whereas you have no guarantees with the HELOC. Yes, debit is bad but you need to save and utilize the debt snowball method to pay down all your debt, including the HELOC. I would say the HELOC would be lower on the priority list than a credit card in terms of paying off.
It's an issue of how much of a safety net you want, and part of that is going to be how much of a safety net you have in other areas. You should take into account what regular expenses you have, what emergency expenses you might have, what insurance policies you have, what deductibles those policies have, and what sources of money you have. As Alex B says, a HELOC isn't a guaranteed source of money, but it is one contingency. If you have a large amount of equity and your local real estate market is stable, your bank could cancel your HELOC, but they would have no financial incentive to do so.
Other possible safety nets to consider would be friends and family, credit cards, and loans backed by retirement funds. Obviously you shouldn't rely on the last two for everyday expenses, but it's reasonable to consider them as contingencies in true emergencies.
Also, if you have a significant net worth, home equity and savings account should not be the only places you're storing your wealth. Look into stocks, bonds, and money market accounts. Your expected returns in the stock market should be higher than the interest you're paying on the HELOC. Stocks are more risky and obviously you shouldn't put all your savings there, but it is one more basket to put your eggs in, and unlike a savings account your money isn't just sitting there.