Pay off 0% loan to open HELOC as emergency fund?

[brandino29]

I just hit a small snag in our near-term financial plan as part of quitting my job to go back to school in a few months. 

As an emergency buffer, I planned to open a HELOC that we had no intention to use but that could provide a backstop if anything unexpected happened over the next 4 years while I'm in school.  It turns out, however, that no bank will give us a HELOC as it stands because we have a 2nd lien on our home from the down payment assistance that we used to purchase the home in the first place through our local housing program. 

At the time, I thought it was an incredible deal, rather than putting down the 3.5%, we qualified for a $3,000 down payment assistance loan with 0% interest for 10 years with a 3 year deferral.  We've been in no rush to pay it off because of the 0%, taking the deferral and paying the minimum $25/month since the deferral ended.

If we want to be able to open a HELOC we either need to a) pay off the loan in full, currently $2,800, or 2) roll it into the HELOC that we would open meaning that $2,800 which is currently 0% interest would take on the HELOC rate (best I've found so far is prime rate, 3.25% I believe). 

Is it worth it to open an emergency HELOC by either forking over that money now and reduce our emergency fund at the time I start school from ~10,000 to ~$7,000 or rolling into a brand new HELOC and pay on it at the going interest rate (variable, updated quarterly)?

My feeling is no, but I'm wondering if anybody thinks otherwise and could convince me it's a good idea.

[t-rymz]

It sounds like what you need is a cushion to cover anything unexpected during school. One way to do this, as you suggest, is to get the HELOC.

Another way of skinning the same cat might be to get a credit card now (while you're employed) with a nice high limit. Then in case there's an emergency, you have money immediately on tap. Afterwards, you can find a better way of getting a lower interest rate. That would be the time to get the HELOC.

Another alternative might be a line of credit from your bank attached to your checking account.

As far as paying off the small loan now goes, it doesn't matter too much. You're looking at pretty low fees for all of these anyways. Just don't roll the small loan into the HELOC. You want the credit line to go untapped.

[aj_yooper]

A far out idea would be to save up some cash.

[Jack]

I'm in a similar situation (with a 0% down-payment-assistance loan that turns into a grant after 10 years) and knew that it makes it more complicated to refinance but until now didn't realize it also precludes a HELOC.

I know when I inquired about refinancing (which I'm still planning to do, but haven't done yet for other reasons) I was told that it was possible to get something called a "letter of subordination" from the down-payment-assistance lender and keep the second lien instead of rolling it into the regular mortgage. I don't know if that would also work with a HELOC, but at least it's the right terminology to ask about.

I almost started suggest a cash-out refi instead of a HELOC, but that only make sense if you know you'll need the money instead of only "maybe" needing it in an emergency.

[brandino29]

Another way of skinning the same cat might be to get a credit card now (while you're employed) with a nice high limit. Then in case there's an emergency, you have money immediately on tap. Afterwards, you can find a better way of getting a lower interest rate. That would be the time to get the HELOC.

We're currently sitting on 3 credit cards (all zero balance) with $10,000 total in spending limits.  My hope was to use that as a back up to the back up (HELOC) since the interest rates are so much higher than a HELOC would ever be. 

A far out idea would be to save up some cash.

Truth, and we are.  We're also going to be living on a much tighter budget starting August 1st and our savings rate will drop big time.  Just wanting to be prepared for the worst, while hoping for the best.

I'm in a similar situation (with a 0% down-payment-assistance loan that turns into a grant after 10 years) and knew that it makes it more complicated to refinance but until now didn't realize it also precludes a HELOC.

I know when I inquired about refinancing (which I'm still planning to do, but haven't done yet for other reasons) I was told that it was possible to get something called a "letter of subordination" from the down-payment-assistance lender and keep the second lien instead of rolling it into the regular mortgage. I don't know if that would also work with a HELOC, but at least it's the right terminology to ask about.

I almost started suggest a cash-out refi instead of a HELOC, but that only make sense if you know you'll need the money instead of only "maybe" needing it in an emergency.

I'll have to ask about that.  It wasn't mentioned by the last two people I spoke with, a mortgage officer at a bank that was the first one to bring this to my attention, and then a customer service rep at the housing assistance program where our loans originated.