A look at the unemployment rate, 9.1 percent in August 2011, shows that the road to economic recovery hasn't gotten any smoother for many Americans. In a world where it seems that nobody's job is 100 percent safe, are you prepared to weather a rough stretch if you lose yours?
If you have some home equity available, now--not after you lose your job--might be the time to prepare for the worst.
A home equity line of credit (HELOC) is an inexpensive and simple way to craft your own safety net. Current mortgage rates remain near unprecedented lows, and that also includes HELOCs, which carry variable rates based on depressed financial indexes such as the prime rate or the LIBOR.
Note: Many lenders have "floors" on how low the interest rate can go. Even if you are offered a "prime plus zero" HELOC , which should be at 3.25 percent today, a lender may have put a floor of 4.5 percent on that calculation, so your rate would be 4.5 percent. Ask about floors and check the fine print!
Fees to set up HELOCs are generally less than $500 and may even be waived altogether by the lender. Best of all--unlike with a home equity loan--you don't pay interest at all if you don't tap the credit line. However, there may be annual fees charged if you don't use much (or any) of the line in a given year.
Compare home equity line of credit rates and see how affordable emergency funds can be.
The basics of borrowing home equity
Credit line amount: Most mortgage lenders today cap the amount you can borrow from home equity at 70 to 80 percent of your home's value. The days of 100 percent home equity financing are long gone. However, some home equity lenders are willing to go as high as 85 percent for well-qualified applicants.
So how much can you borrow?
If your home is worth $300,000 and your first mortgage is $220,000, you're already borrowing more than 70 percent of your home's value. You'd probably need to look for a mortgage lender offering an 80 percent loan, which would get you access to $20,000 (or a combined maximum loan balance of $240,000). An 85 percent loan would get you $35,000.
A credit line of $20,000 to $35,000 could come in very handy if you end up losing your job and have to rely on unemployment insurance.
When and how to tap a home equity line of credit: It's smart to budget before you borrow. Financial experts recommend saving up an emergency fund with enough money to cover at least six to 12 months of expenses. If you don't have this yet, scale back on your expenses now and funnel extra cash into your savings account.
If you find yourself out of work and think you may need more than what you've saved, tap your HELOC for the difference and stash those additional funds in the savings account.
Why draw on the line of credit right away and move it into savings?
As homeowners around the country have discovered, a home equity line of credit can be cut or curtailed with little or no notice. After you've drawn on your line of credit, though, those funds are safely in your hands.
Interest payments: What do the interest payments look like? If you transfer $20,000 from your HELOC to your savings and your home equity lender charges 4 percent interest, your monthly payments would be:
- $67 for an interest-only loan
- $95 for a 30-year term
- $121 for a 20-year term
Understand, however, that home equity line rates are variable and could rise to much higher than 4 percent. That's why you still want to use as little money as possible and pay it back as soon as you get back to work.
HELOCs beat tapping your retirement accounts
Borrowing against a 401(k), IRA or similar tax-advantaged retirement account can seem like a cheap source of emergency funds. It can be, unless you lose your job.
Remember that a 401(k) plan is tied to your employer. (In fact, if you've borrowed from your 401(k) and lose your job, many plans require immediate repayment.) If you can't repay within five years, the amount you borrowed gets taxed as income. Not only that, you get hit with a 10 percent early withdrawal penalty, which is also what happens if you tap your IRA for emergency funds.
On the other hand, money borrowed from home equity does not get taxed. In fact, you may even be able to deduct the mortgage interest you pay on your Schedule A.
If you're let go
Surviving unemployment means paying your most important bills, like your mortgage, first, and protecting what assets you can.
1. Negotiate with your creditors: A call to all your creditors the minute you get a pink slip can get you temporary interest rate reductions, especially if you have been a good customer and have paid on time every month. Many credit card companies will drop your rate to single digits, even to zero, for up to a year if you hit a rough patch.
2. Get a break on your first mortgage: Call your regular mortgage lender and apply for HAUP, which the federal government's program for distressed homeowners that lets you skip or reduce your mortgage payments while you're unemployed.
3. Reduce cash expenditures any way you can: Switch to cheaper cellular plans, cable packages and internet service. Up the deductibles in your auto insurance and homeowners insurance. Trade eating out for home-cooked fare.
There are many very good websites offering money-saving tips if you're unemployed. Find the ones that work for you, and make job hunting a priority so you can get back on your feet.
Gina Pogol has been writing about mortgage and finance since 1994. In addition to a decade in mortgage lending, she has worked as a business credit systems consultant for Experian and as an accountant for Deloitte. She graduated with High Distinction from the University of Nevada with a BS in Financial Management.