Before you shoot me for the title, I do need an emergency fund. In fact everyone needs to have one. However, I had one that’s a little non-traditional. Of the people that have emergency funds, it seems like most have them in bank accounts earning very little interest. Some of them are smart and get an account like an ING or Emigrant Direct that pays a much higher interest rate. I can’t argue with that plan, but I chose to go a different route.
I set up a Home Equity Line of Credit (HELOC). I’ve tapped into it from time to time and it’s hurting me a bit to pay 8% on the loan. However, I’m making about 19% (16% after adjusting for risk) on my Prosper account. I’d make 8% by simply borrowing more from my HELOC and lending it out on Prosper. With Prosper being new and somewhat unproven, I’ve decided to hedge my bets and split my money between paying off the HELOC and lending out money.
Back to the HELOC as an Emergency Fund. I think people generally tend to be in the “emergency state” for 6 months and typically they are very rare. If I can earn better than 4-5% more on a 6 month safety cushion than I can in a high interest bank account, I think I’ll come out far ahead over 30 years.