By Remigiusz Stanisławek
When advisors first meet with a new client, emergency funds are an almost-inevitable topic.
These financial safety nets, containing enough cash to cover six months of expenses, are a critical first step for any client starting to get their financial house in order.
Unfortunately, clients may need years to build these accounts up to optimal levels, even with careful budgeting and planning. But emergency fund needs won’t necessarily wait – surprise tax bills, familial obligations and unplanned healthcare costs can come at any time.
To ensure clients have immediate means to cover unforeseen costs, advisors should consider the merits of personal lines of credit as an alternative to standard emergency fund plans.
Lines Of Credit Basics
Lines of credit for individuals work the same way as those for businesses: they fulfill financial needs when those needs’ exact costs remain unknown. Clients can open a personal line of credit with most major and some regional banks in the U.S., though banks rarely advertise lines of credit for personal use given the more popular alternatives available.
To improve their chances of approval, clients should apply at the bank where they have their checking account and maintain a good credit score.
Once a client opens a personal line of credit, they can access it alongside their checking and savings accounts. Until they actually make a withdrawal from the line of credit, they have not borrowed any money and no interest is accumulating. In this way, lines of credit function very similarly to credit cards.
Luckily for your client, their new line of credit probably has a lower interest rate than they would for a credit card with the same credit limit. This is especially true if your client secured their funds with their home or car as collateral.
Keep in mind, though, that clients cannot obtain home equity lines of credit as easily as before the Great Recession due to post-recession regulations restricting banks from working with shaky mortgages.
Once secured, clients can use their personal line of credit as a stopgap while they build up an emergency fund or simply use it as the fund itself. Of course, a major downside of only using a line of credit is that any money used must be paid back with interest.
Clients who forego traditional financial backstops entirely will have to make harsher budget adjustments to pay off debt should they use credit to fill the gap.
Merits And Potential Pitfalls
For clients capable of fiscal restraint, lines of credit offer more than just an ability to pay emergency bills. With the immediate need to for a financial stopgap satisfied, clients can pay into retirement accounts or purchase disability or life insurance. They can also use the opportunity to make payments on other, higher interest forms of debt, like student loans.
A crucially important benefit of lines of credit is empowering clients to avoid the payday loan industry. Payday loans often come with effective interest rates of up to 400 percent and can trap borrowers in a cycle of debt and poverty.
The allure of payday loans is their immediacy, which the long-term work required to build an emergency fund cannot replace – but personal lines of credit can.
Lines of credit also remove the potential necessity of choosing between paying bills or financial health. With a sum of money already at their disposal, clients will hopefully never have to choose between making rent and getting a necessary surgery.
This extends to lower-stakes dilemmas, such as deciding between getting ahead of debt or purchasing subsidized health insurance.
Even with all the possible benefits, lines of credit come with the same pitfalls as other forms of borrowing money. Clients who have trouble with financial discipline may struggle to use lines of credit appropriately, just as they might a loan or credit card. On the other end of the spectrum, clients spooked by borrowing money at all might be put off by lines of credit, too. Both kinds of clients might be better served with other options.
Lines of credit can also come with annual or monthly fees – which can be framed as the cost of not aggressively reigning in their budgets to rapidly rack up a full emergency fund on their own.
Emergency funds remain the foundation of any client’s financial success, but life does not sit and wait quietly for clients to prepare for unexpected bills. Personal lines of credit, when available and appropriate, can offer clients an immediate solution to an immediate need, while opening the door to a more stable fiscal future.
About The Author
Remigiusz Stanisławek is an 8-year and Top of the Table MDRT member and the owner of Rodzinne Finanse. He has worked in financial services for over 10 years and focuses on helping families grow their savings and begin investing. Remigiusz lectures for the Poznań University of Economics and the European Academy of Financial Planning and is a Polish representative for the Pan-European Personal Pension project. He lives in Poznań, Poland. By joining and engaging with industry peers via associations like MDRT, you can keep your skills at the top of their game.