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  • Where can I turn when my household income runs dry?
  • February 6, 2013
  • Where can I turn when my household income runs dry?By Mike Mosser

    Whether it’s the loss of a job, unexpected medical expenses, home repairs or just putting the kids through college, anyone in a financial bind has a variety of resources they can turn to—particularly if they already have a bit of equity to borrow against.

    Options include – borrowing from a life insurance policy or a 401(k) plan; tapping a home equity loan; an ordinary refinancing; or getting a reverse mortgage.

    Of course no discussion of these issues would be complete without first mentioning the importance of financial planning to try and avoid this scenario. Each of these options comes with potential drawbacks to the point where some financial analysts argue for just avoiding them altogether.

    Additional sources for information on reverse mortgages and financial planning in general.

    The Department of Housing and Urban Development’s information page on Home Equity Conversion Mortgages
    click here.

    HUD’s HECM counseling agencies

    Find a HUD-approved reverse mortgage counselor at this address or by calling 800-569-4287.
    click here.

    Top 10 things to know if you’re interested in a reverse mortgage
    click here.

    10 things you should know about reverse mortgages
    click here.

    Frequently asked questions on reverse mortgages, from the National Reverse Mortgages Lenders Association
    click here.

    Financial Planning Association

    Information on investing and finding a financial planner
    click here.

    Certified Financial Planner Board of Standards

    Consumer guides on financial planning and resources for finding a financial planner
    click here.

    The National Association of Personal Financial Advisors

    Includes a “field guide” on finding and evaluating a financial advisor
    click here.

    Of course no discussion of these issues would be complete without first mentioning the importance of financial planning to try and avoid this scenario. Each of these options comes with potential drawbacks to the point where some financial analysts argue for just avoiding them altogether.

    Bill Palmer, senior financial advisor and a Certified Financial Planner with Win Wealth Management in Denver, Colo. says everyone should have about six months of living expenses set aside in an emergency fund which they can earn interest on, rather than borrowing when they get in a pinch.

    “These are solutions for people who are not planning so why not better serve those people by encouraging them to plan and to save and to live within their means, or better yet below their means so that they can save. It’s all about striking a balance between consuming today and starving tomorrow,” Palmer says. “Interest is a reduction in your total cash flow so if you don’t have to pay interest in the grand scheme you’re much better off.”

    Palmer suggests keeping a reserve fund in a four-year Certificate of Deposit to earn interest, then pay whatever penalty might arise from having to draw on that money in an emergency.

    Yet not everyone is willing or perhaps able to follow that advice. Anyone reading this article might be at the point where they need resources now. That’s why we’ll take a look at each of these options and consider the issues surrounding all of them.

    “Any resource can be a tool so long as it’s wisely used. It doesn’t matter whether it’s a reverse mortgage or a home equity credit line or you borrow cash value from your life insurance policy or 401(k) plans,” says Neil Van Zutphen, president of Delta Ventures and a Certified Financial Planner in Mesa, Ariz. “You have to think of each as its own tool and understand the pros and cons of each of the tools.”

    He says the first step, before even considering these options, is to cut back on expenses and save as much as possible. While tapping these resources can help those in a bind, they can easily let someone get lulled into a false sense of financial security.

    “They spend at a normal level when they should be saying to themselves holy smokes I need to really ratchet this down and spend the least amount possible so that we can preserve and conserve our capital for as long as possible,” Van Zutphen says.

    Refinancing

    At a time when interest rates are at such low levels, a simple refinancing could reduce a mortgage payment and provide extra cash in a homeowner’s budget. Unfortunately, a weakness in the housing market means anyone who bought a house within the past few years is probably underwater as their home could be worth far less than the mortgage they have on it.

    “If you have at least 20 percent equity in your home you ought to have a good opportunity to refinance, if you have good credit, and obtain historic low interest rates,” says Samuel Tamkin, a Chicago-based real estate attorney, real estate expert and columnist for ThinkGlink.com.

    “Recently I talked to someone who said they were offered a 2 ¾ interest rate on a 15-year mortgage. That interest rate seemed so low to me that it was almost free money,” Tamkin says.

    While some homeowners might be tempted to get extra cash from refinancing by borrowing more than they have in their existing mortgage, Tamkin says this could be difficult unless a home’s value is substantially higher than the new mortgage amount.

    Palmer says refinancing would be an option for those whose loan to value ratio is at 80 percent, although he warns against pulling excess capital out of a mortgage as most people aren’t responsible enough to use that money wisely.  He suggests putting money into an index fund rather than trying to beat the markets.

    “For those who have discipline then I’m okay with having a home mortgage that you take cash out of when you refinance if you immediately invest it in a long-term investment plan and you don’t gamble it on speculative investments,” Palmer says. That’s the only time when I would encourage somebody to take out cash, but the rule of thumb is if the rate of the debt cost you less than the highly probable expected return, not an eyes in the sky end of the rainbow expected return, but something pragmatic and realistic.”

     

    Untapped financial resources and life insuranceHome equity loans

    Home equity loans and Home Equity Lines of Credit are basically second mortgages of a different name. They allow a homeowner to borrow against the equity in their home at rates lower than other means of borrowing, such as a credit card. (see sidebar)

    A home-equity loan provides a one lump payment at a fixed rate and is generally used for a set amount of money for specific purpose, such as repairing a home or building an addition.

    A HELOC comes with a variable interest rate that usually tracks the prime lending rate, plus a few points. A borrower gets special checks they can draw on at any time and are often used as an emergency fund.

    The HELOC doesn’t accrue interest charges until the line of credit is actually tapped by the borrower, so it can function as a backup financial plan in case of emergency. A HELOC can be revoked or altered at any time by the bank for various reasons, such as a substantial decline in a home’s value or a change in the homeowner’s finances.

    “It’s only there in the event of a true emergency. If you lose your job or both of you lose your jobs,” Van Zutphen says. “You try not to tap into it all at once, you just use it as you can and then try to pay it back as quickly as possible.”

    Interest rates are low enough to make a home equity loan affordable, Tamkin says, although it’s unlikely that anyone who bought a home within the past seven years or so would have enough equity in their home to borrow against.

    “Some markets you may have seen prices go back to around the year 2000 but if you bought in 1994 and you’ve been in your home almost 20 years, you may still have a substantial amount of equity in your home, particularly if when you refinanced you only refinanced prior balances and didn’t take additional money out,” Tamkin says.

    Palmer says the best use of a HELOC is to have one on hold with a bank, but only as a backup resource to an emergency fund that can be used after a six-month savings reserve has been depleted.

    Pages: 1 2

  • Category: Featured Story, Life Insurance

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