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Tap your equity before you are laid off if you plan to get a second mortgage to see you through hard times.
That's good advice because, barring some special collateral deal or other unique underwriting provision, lenders aren't likely to loan you any money if you are jobless. If you know you are among the next round of layoffs and borrow anyway, you could compound your financial difficulties.
"Is it unethical ... if you know you are being laid off and you will have no means of repayment? Yes, if you are doing a loan where employment and income are necessary to qualify for the loan, you would be omitting a material fact and defrauding a lender. That's lying on an application. That's fraud and a federal offense," said Ginny Ferguson, vice president of the National Association of Mortgage Brokers (NAMB).
"Consumer's need to be proactive and put any safety net of financing into place long before it is necessary. A better suggestion is to secure a HELOC (home equity line of credit) long before that becomes an issue, if you are in a line of work that has a possibility of layoffs," said Ferguson also broker and co-owner of Heritage Valley Mortgage, in Pleasanton, CA.
Unemployment averages 6 percent nationwide. The rate is higher in some hard hit areas. Most states continue to lose thousands of jobs a month. That all makes banking on your home a good idea, provided you get the right equity loan at the right time.
There are three common ways to tap your home equity.
HELOC A second mortgage, a home equity line of credit (HELOC), is a revolving credit line that acts much like a credit card, but without the higher interest rate. Rates recently ranged from 4 percent to 5 percent, according to BankRate.com and are typically adjustable, but fixed rates are available. Up front, HELOC's don't cost you any more than minimal application fees, perhaps an appraisal and a few other costs. Interest doesn't kick in until you actually use the money. As you repay the balance, the credit becomes available again.
Equity Loan An equity loan is a second mortgage for a fixed amount. It comes with financing costs similar to those for a HELOC. The installment mortgage loan forces you to begin making payments right away, even if you don't use the money right away. Rates were recently at about 6 percent to 7 percent, according to BankRate.com, but they tend to be fixed rates.
Cash Out You can also tap your equity when you refinance with a cash-out refinance that increases the balance of your first mortgage but, if the new interest rate and your new loan balance are low enough, you could still have a smaller monthly payment -- and only one monthly mortgage payment. Financing costs range from zero for higher interest rates to thousands of dollars for lower rates. Rates on conforming, 30-year fixed rate loans recently averaged as low as 5 percent according to some.
Conservative experts advise against ever using your equity. They say the idea behind a 30 year mortgage is to give you enough time to comfortably pay it off before you retire so you can live "rent free" on your fixed income.
Most financial and investment experts advise that you only use equity for capital improvements and investments that provide an equal or better return on your money than the cost of the loan. Certain home improvements, education for the kids and new business financing are relatively better uses of equity than say buying cars and boats, debt consolidation and vacations.
An exception to all the rules, is to use your equity for emergencies and unforeseen events of limited duration that might reduce your income or place added demands on your wages, including births, deaths, illness, injuries and, the subject here, job loss.
"I think it is a good idea to get the loan while you can still qualify and I see a lot of this right now," says Joette Joseph in San Jose, CA. "An equity loan might just be the cushion that can help you stay in your home until you find another job. It's important to know your own spending habits. If you know you are really bad with money, then it is probably not right for you," said Joseph.
Financial planners and investment counselors say the first line of defense in any household budget is not an equity loan, but a highly-liquid emergency savings account that can handle at least six months worth of household bills.
For those who've been unable to put aside such an emergency fund, the inability to save could be a red flag warning you about your ability to repay a loan during hard times.
If you do go the equity borrowing route, it's crucial to consider how you'll repay it -- not to mention your first mortgage and any other bills -- especially if you are unemployed for an extended period.
Again HELOC's may be the equity loan of choice because during its term you often can pay interest only, while using the cash to pay your first mortgage and other bills.
"Equity and self-interest go hand in hand on this issue. If there is a high probability that your setback is temporary, you take the loan to keep your first mortgage current, and you pay it back when you get on your feet," said Jack Guttentag, publisher of the "Mortgage Professor" consumer Web site, a mortgage writer and founder of GHR Systems, Inc. in Wayne, PA.
"If the setback is going to be permanent, it is foolish to use up your equity by taking a HELOC. Instead, you sell the house and preserve the equity, as well as your credit rating," he added.
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