Protecting Your Home & Finances in Tough Times

With the nation possibly facing the worst financial crisis since the Great Depression, and as many as 6 million homeowners at risk of foreclosure, we all need to review our finances and make sure we are well positioned for the future. Home values, the stock market and the economy will eventually recover, so the main goal is to make sure we protect our finances as best as possible in the meantime.

The appropriate action is related to your liquidity. If you have enough cash and liquid assets to cover one year’s worth of living expenses, you’re in pretty good shape for the near term. Liquid assets include things that are often overlooked, such as IRAs, 401Ks, cash surrender or withdrawal value for life insurance and/or annuity funds that are immediately accessible, so you may be in better shape than you think. There may be penalties associated with some of those withdrawals, so tap them only as a last resort.

While regularly reviewing your financial status is a good idea for everyone, there may be no need to modify a thoughtful and balanced long-term financial plan if you have sufficient liquidity. Homeowners with minimal liquid reserves need to take action soon to strengthen their ability to access cash if they need it in increasingly uncertain times. Uncertain economic times can threaten even the safest jobs, and jobs take longer to find during a recession. For homeowners with less than a year’s liquid reserves, a top priority should be to protect their limited liquid assets, look for ways to expand liquid assets, and look for ways to improve your ability to get additional cash in the future if you need it.

There are four important steps smart homeowners should take to protect their financial security:

• STEP 1: Review your home financing structure
• STEP 2: Review the allocation of other investments
• STEP 3: Make sure you're adequately insured
• STEP 4: Build liquidity by reducing unnecessary personal expenses

Review your home financing structure and take action if necessary.

If you have a 30-year fixed-rate loan at current mortgage interest rates or less, no action may be necessary if you have enough cash and liquid assets to cover one year’s worth of living expenses. If not, refinancing your mortgage to reduce payments or prevent future payment increases may be a good idea if you have equity in your home.

If you have sufficient equity and your credit score is sufficient, you may be able to take out cash in the process, which is a particularly good idea if you have little savings and/or you can significantly lower your mortgage interest rate through refinancing. If liquidity is a challenge and you're eligible for a home equity line of credit, apply now so it will be in place in case of a crisis. Things are trickier for homeowners with mortgages that are “underwater” (the mortgage balance exceeds the home’s current market value). Most lenders won’t forgive the difference unless you’re behind on payments and are out of money, and even then they are far more inclined to a restructuring that would temporarily reduce payments to an affordable amount while maintaining the mortgage balance.

A new “Hope for Homeowners” FHA program may enable some homeowners to get part of the mortgage debt forgiven and refinance with a 30-year fixed-rate mortgage. Yet other alternatives may emerge out of the current Wall Street rescue effort over the next few months. In most cases, a foreclosure should be avoided if possible.

In some cases, it may actually be in the homeowner’s best interest. For example, some financially-pressed homeowners whose mortgage balance far exceeds their home’s value have recognized that it will probably take many years for the home’s market value to catch up with their mortgage balance. In the meantime, they are also trapped in their present home and unable to sell and take advantage of better job opportunities in other areas. By the time home values do catch up, many could have restored the damage done to their credit rating by a foreclosure, and they would have advanced in their career as well.

Review the allocation of your other investments.

Experts recommend diversification in good times and bad. If you don't have enough liquid assets to cover at least one year’s worth of living expenses, rebalance your investments to minimize the risk of further erosion of their value. Sell individual stocks and mutual funds and buy conservative investments like AAA bonds and federally insured savings accounts and federal, state and local bonds. They will hold their values in declining stock markets.

While conservative investments will also trail other investments in appreciation when the market recovers, it’s better for homeowners with liquidity to be safe and miss out on some opportunity for investment growth until the market recovers. Conversely, homeowners who are in good shape financially probably need not restructure a well-balanced investment portfolio.

When recovery begins, appreciation of securities will outstrip growth of more conservative investments. Timing such market changes is notoriously difficult, and homeowners with balanced investment portfolios are usually better advised to stay in the market and benefit from all of that recovery.

Make sure your investments, insurance policies, IRAs, and/or annuities are adequately insured.

Bank deposits are covered by the Federal Deposit Insurance Corporation (FDIC), which guarantees bank account balances of up to $100,000 in a single bank ($200,000 for joint accounts). If you have accounts in more than one bank, each account is covered by those limits. FDIC protects IRAs kept in bank accounts up to $250,000.

Make sure that any other investments through stockbrokers or other financial service firms are insured by the Securities Investor Protection Corporation (SIPC). SIPC protects the assets in your investment account from losses due to a financial services firm’s bankruptcy, but it does not protect you from losses due to stock market declines. SIPC covers up $500,000 per customer, including up to $100,000 for money market funds.

With the failure of giant insurer AIG, many homeowners are concerned about the status of their life insurance and/or annuities. Life insurance policies are insured by each state’s guaranty association. Typical coverage is $100,000 in cash surrender or withdrawal value for life insurance and $100,000 in withdrawal and cash values for annuities.

If you need to improve your liquidity, reduce unnecessary personal expenses and stop making any extra payments on your mortgage.

To build your savings, cut back on expensive vacations and non-essential activities like hobbies and expensive restaurants. Look for other ways to save money as well (never a bad idea even if your finances are strong). 

Provided by the American Homeowners Foundation.