California and the rest of the nation is teetering on the brink of a recession--if we aren’t in one already. Unemployment is up, economic growth is down. Most economists say the picture will grow even bleaker next year.
Considering all the grim evidence of a downturn, now’s a good time to do some financial planning.
And if you’re a homeowner who is uncertain about your economic future, you might be able to take your mortgage and the equity you have in your house and fashion them into a financial parachute in case your job becomes a casualty of the rough times ahead.
Of course, tapping your equity or restructuring your current loan isn’t something to do without some careful thought first.
“The equity in your home should be one of the last things you touch if you run into financial trouble,” cautioned Jack Blankinship, a partner in the Del Mar-based financial planning firm of Blankinship & Foster.
“But you shouldn’t let your equity or your mortgage stand inviolate if you’re afraid that you’ll lose your job and run out of cash.”
If you’re worried that you or your spouse might get thrown out of work next year, it might make sense to refinance your loan now or set up a home-equity line of credit before the ax falls.
After all, it’s a lot easier to get a loan or obtain a large credit line when you’re working than when you’re unemployed.
Remember, however, that planning to use your home equity as a financial “safety net” during hard times can be risky.
“If you buy a washing machine and miss a few payments, the lender can repossess jyour washer,” said John Cahill, a San Francisco-based financial planner. “But if you borrow against your house and miss a few payments, your lender can take away your home.”
Perhaps you have stocks, bonds, collectibles or other valuables that can be sold to raise cash. Or, you might be able to borrow against the value of your life-insurance policy or retirement account. (For more ideas, see the story on K 4.
If you have weighed all your options and decided that it makes sense to put your mortgage or home-equity to work for you, it’s important that you move cautiously.
One relatively conservative way to use your mortgage as a safety net is to set up a home-equity line of credit.
“The idea is to set the line up now in case you need it later,” said Lawrence A. Krause, president of a San Franciso-based financial planning firm that bears his name.
“If you fall on hard times, the credit line will ensure that you have instant access to cash.”
Since you won’t need to tap your credit line right away, it’s probably best to look for a lender who won’t charge you much to set the line up.
“It wouldn’t really make sense to spend a few hundred or a few thousand dollars to set up a credit line that you might not ever use,” said Stacy Ann Schramm, a planner with IDS Financial Services in Pasadena.
“If you do a little shopping around, you should be able to find a lender who’ll give you a credit line with little or no up-front charges.”
Indeed, many lenders today are advertising credit lines that don’t cost anything to establish.
Also call the lender who holds your current mortgage and the institution where you’ve got your checking or savings account. Some lenders will reduce or eliminate up-front charges for their customers, or they will give them a credit line with an interest rate that’s slightly lower than they charge on new accounts.
Remember, though, that just because a lender doesn’t charge any up-front points or application fee to set the line up doesn’t mean you’ll get the line for free.
Some lenders charge hundreds of dollars for property appraisals, processing, credit reports and the like. So, make sure you ask the lender to detail all the charges you would incur before you agree to take the line out.
Of course, you might not mind paying several hundred dollars in up-front charges if you find a credit line that has an unusually low interest rate or some other attractive feature.
Also make sure that you understand how the loan actually works. Since most credit lines have adjustable rates, you’ll need to know how often the rate is changed and which index is used to make the periodic adjustments.
If you’re low on savings but have built up lots of equity, you could also consider refinancing your mortgage and drawing out enough cash to tide you over if you lose your job.
For example, let’s say that you bought your house for $100,000 about six years ago. Monthly payments on your $80,000, 11% fixed-rate loan are $762.
If you refinanced your home for $100,000 at the going rate of 10%, your new monthly payment would be $878.
Although your new payment would be $116 a month higher, you could offset the difference by taking the “extra” $20,000 you had left over and putting it in a money market account paying 8% interest.
In addition, you could dip into the $20,000 to make your monthly payments for up to two years if you find yourself out of work for an unusually long period of time.
If your chief goal is to lower your monthly payment, you could consider refinancing your current loan with an adjustable-rate mortgage that carries a low introductory rate.
For example, say you have an 11%, fixed-rate loan with an outstanding balance of $120,000. Your monthly payments are about $1,145.
If you refinanced your mortgage with an ARM that will have an 8% rate for the first year, your monthly payments would drop to about $881.
“By the time your interest rate (on the new ARM) adjusted to market levels a year or so from now, you’ll probably have a new job and will be back on your feet again,” said Lewis Wallensky, a financial planner who owns his own firm in Los Angeles.
In fact, Wallensky said, you might even be able to refinance your mortgage with an ARM, draw out $20,000 or more in cash, and still lower your monthly payments for the next year or two.
Again, the money you pull out could be put in the bank and used to help you weather a financial storm.
If you’re thinking of setting up a credit line or tapping your equity through some other method, how much should you borrow?
“An old rule of thumb says that for every $10,000 you earn each year, it’ll take one month to get a new job,” said Blankinship. So, if you’re making $50,000 a year, you might want to set up a credit line that’s high enough to tide you over for five months.
Of course, there are exceptions to this rule. If your job is in a thriving industry, you might not need such a big line of credit because you’ll probably be able to get a new job relatively soon.
Conversely, if your job is in an industry that’s suffering--such as the aerospace or construction business--you might want to set up an unusually large loan or credit line because you could be out of work for several months.
If you are like most taxpayers, you can borrow up to $100,000 based on your home equity and still write off all your interest charges. But if you borrow more, you won’t be able to deduct the interest you pay on the overage.
Of course, it’s a whole different ballgame if you have already lost your job or you have been notified that you’ll lose it soon. Most lenders are hesitant to loan money to people who aren’t working, even if they’ve got lots of equity in their home.