A home repair emergency fund can save you from financial disaster. While it's easy to believe your house is in great shape, you never know when you’ll have to deal with an expensive plumbing bill or a flooded basement.
If you don’t have money set aside for repairs, you might be tempted to use your credit card. However, unless you're able to pay them off immediately, charging costly home repairs is never a wise financial idea—it'll accrue interest and leave you with an even larger bill later.
The better solution is to think ahead and create a home repair emergency fund.
What’s a home repair emergency fund?
A home repair emergency fund is money set aside to pay for unexpected home repairs—the cash you can grab at a moment’s notice. In other words, you don’t want to put that money into a long-term savings portfolio where you'll face massive fees if you pull money out early.
Homeowners don't need to get too creative with an emergency fund, says Byron Ellis, managing director of United Capital Financial Advisers in The Woodlands, Texas. A savings account in a local bank will suffice.
How much money should you save in your emergency fund?
Ellis suggests homeowners create a cash reserve of three to six months of living expenses. You cash reserve target should be about 1% to 3% of your home value. So, if your home is worth $500,000, Ellis suggests setting aside $5,000 to $15,000.
Of course, each situation is different. A homeowner with a new home with all new systems and appliances might not need to tap into a home repair emergency fund. Fixer-uppers and old homes, of course, will likely require that money sooner.
General emergency funds
In addition to a home repair emergency fund, it's also wise to create two general emergency funds: an everyday emergency fund and a dire emergency fund. Everyday emergencies—such as needing a new boiler in your home—can cut into your monthly budget, so having some cash stowed away will allow you to still pay your rent or mortgage. Shoot for having about 10% of your annual wage in your everyday emergency savings account, says Robert Reed, a partner at Partnership Financial in Columbus, Ohio. If you’re self-employed, Reed says to put aside 20% of your yearly salary since the income is variable.
The second emergency fund—the dire emergency fund—is for life’s calamities that interrupt your income. It could be losing your job, falling ill and needing to take time off work, or dealing with a death in the family.
“Our concern when something catastrophic happens is that people could risk losing their home because all of a sudden they can’t make their mortgage payment,” Reed says.
Reed recommends working toward saving 20% of your mortgage balance for the dire emergency fund. Put aside money from each check and you’ll quickly begin to get closer to your goal. For instance, putting aside $25 every week will get you $1,300 in a year.
Use a savings or money market account for your emergency fund. You shouldn’t use a brokerage account since that fluctuates.
What to do if you don't have an emergency fund
Let’s say your central air-conditioning system dies in the middle of summer and you desperately need to replace it, but you don't have a home repair emergency fund. Where do you turn? Two options are a home equity loan and a home equity line of credit, or HELOC.
Both of these let you tap into the value of your home to cover costs. A major difference is that the home equity loan is a lump sum and you often have a fixed interest rate. HELOC is a line of credit that you can borrow. A HELOC lets you draw money from the account as much as you need up to the available maximum amount. Also, a HELOC usually has an adjustable interest rate.
You can think of a home equity loan as a way to pay for a significant renovation project, while a HELOC is more likely going to help you with smaller projects that crop up over time. You tap into the HELOC only if you need it.