Outside of the pandemic that nearly closed the entire economy, unemployment rates have been at or near historically low levels for years. That said, one thing that is certain is that good times don't last forever, and even a mild economic downturn could see millions of homeowners lose their jobs -- and you could be one of them. In a world where it seems that nobody's job is ever 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.
Although home values of course can go up and down, home values in most areas have appreciated a lot in recent years, so the value of your home may be a higher than you think and your equity stake fairly deep.
A home equity line of credit (HELOC) is an inexpensive and simple way to craft your own safety net. Current mortgage rates rates are no longer near historic lows, and that also includes HELOCs, which carry variable rates based on financial indexes such as the prime rate or SOFR, but loans secured by your home are still likely to be available at rates lower than those for personal loans or credit cards..
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 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 or line of credit, 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.
Use HSH's home equity calculator to reckon how much you'll have available to borrow at a range of final loan-to-value ratios.
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.
Virtually all HELOC disclosures have clauses that describe the lender's right to reduce access to or even terminate your line of credit if the value of the property should decline significantly, or if they "reasonably believe that you will be unable to fulfill your payment obligations under the terms of the loan due to a material change in your financial circumstances".
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 8.25 percent interest, your monthly payments would be:
- $138 for an interest-only loan
- $150 for a 30-year term
- $170 for a 20-year term
Understand, however, that home equity line rates are variable and could rise to much higher than 8.25 percent (of course, they might decline a bit, too). 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, your plan may 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 isn't considered income and so does not get taxed. Unfortunately, there's also no longer a tax benefit for most home equity borrowing: the mortgage interest you pay when borrowing using a home equity loan or line of credit is no longer a deductible expense unless you use the proceeds to "buy, build or substantially improve" a qualified home.
Using a HELOC as a 'safety net" can carry risks
A home equity loan sees you get your funds in a lump-sum upfront, and you'll need to make payments even if that money is just sitting in an account somewhere... but you'll have those funds available when you need them, if at a cost. A HELOC, however is simply access to those funds, and a lender can take that access away if your financial situation deteriorated. This is known as "curtailment" or "freezing" a HELOC, and it means that you may not be able to get funds when you need them most, and it's important to understand how this works if you're using a HELOC as a safety net.
A home equity loan has no such risks; however, it does have costs, since you'll start making payments as soon as you receive the funds. Since some lenders let you set up a line of credit then break off a piece into a fixed-rate, fixed-term repayment schedule, you might consider doing do despite the cost. You'll make payments now for funds you might need at some point... but isn't that how insurance usually works, anyway?
Your finances... 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: If you are in danger of falling behind on your mortgage payments, contact your mortgage servicer. They may be able to offer assistance that includes everything from temporary payment deference to outright loan modification if troubles are likely to become more permanent. It's best to be proactive; don't wait until you are already missing payments to reach out.
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. Check with your gas and electric providers to see if they have temporary assistance for newly-unemployed folks. 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.
Related: HSH's comprehensive Guide to Home Equity Loans and Home Equity Lines of Credit
Gina Pogol and Keith Gumbinger contributed to this article.
