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Your home equity line of credit can be reduced or canceled if your finances take a turn for the worse, which reminds me of the Seinfeld episode when George Costanza pushed an elderly woman, a clown and a room full of children out of his way so he could escape what he thought was a blazing fire. The clown ended up dousing the blaze with his big shoe. When you think of your home equity line of credit, you should be reminded of George. In an emergency, your home equity line of credit may be the first thing to leave the room.

A few weeks ago, the Wall Street Journal published an article about home equity lines of credit. The article described how some financial institutions were reducing the available credit on home equity lines for borrowers who were having financial trouble. My first reaction was to assure myself that such a fate would never befall me. I pay my mortgage and home equity line of credit on time each month. In fact, I’ve never had a late payment in the four years since I bought my current home, and I even pay the bills automatically from my checking account each month. But then I started to wonder what would happen if I lost my job and started paying some bills late. Would my mortgage company take away my available line of credit?

So I dug through my old files and pulled out my mortgage documents. On page 3 at the bottom of my home equity line of credit agreement, under a heading labeled “Possible Actions,” I found this eye-opener:

We may refuse to make additional extensions of credit or reduce your credit limit if:

• The value of the dwelling securing the line declines significantly below its appraised value for purposes of the line.
• We reasonably believe that you will not be able to meet the repayment requirements of the line due to a material change in your financial circumstances.

So if housing prices decline significantly, my mortgage company (which is a large, well known financial institution) can reduce my credit limit. And if I lose my job, the mortgage company may also be able to reduce my credit limit. In other words, if I hit on hard financial times, just like George, my home equity line of credit may be the first one out the door.

Now I don’t lie awake at night worrying about this, and I’m not suggesting you do, either. But as housing prices continue to fall and inflation moves higher, sound money management dictates that we spend some time evaluating just how you would handle a real financial crisis. How much do you rely on your home equity line of credit as an emergency fund? Do you know how much money you need each month to handle the necessities? If not, check out my approach to an emergency fund.

This is a guest post from a good friend and former colleague named Peter. If you’d like to write for TDR, please drop me a line.

Photo Credit: woodleywonderworksRemember when “junk bond” was a dirty word? People and companies bought these newfangled high-interest rate bonds without fully appreciating that the interest rates were high because the borrowers were shaky. Investors lost their shirts, Michael Milken did hard time, and the economy stumbled. Today, meretriciously renamed “high-yield” bonds, junk bonds are an important cog in our economy’s machinery and a key component in many investors’ portfolios.

What changed? Sunlight and common sense were applied. A better system evolved for evaluating the creditworthiness of high-yield borrowers. Today buyers of junk bonds, by and large, know exactly what they’re getting. For many, the higher risk/reward character of junk bonds is exactly what they need to round out a diversified portfolio. And many worthy companies that would have been cash-starved in earlier times have access to the capital markets.

Today the dirty word du jour is “subprime mortgage.” Read the rest

Last week, FiveCentNickel answered a reader’s question about whether one should cash out a Roth IRA to pay off a mortgage. FCN’s answer was the right one, I believe, and you can read it here. The question is of interest to me because my mom has asked me the same thing. My answer to my mom has always been, “Don’t do it!” Cashing out a retirement account to pay off the mortgage reminds me of 16th Century London. Bear with me.

In the 16th century, money dedicated to Westminster Abbey was redirected to St. Paul’s Cathedral. If you take a tour of London on its famous red double-decker buses, they’ll tell you some of the money was eventually used to rebuild St. Paul’s after The Great Fire of 1666. So what’s the point? Well, Westminster Abbey goes by another name. . .The Collegiate Church of St. Peter, Westminster. And its from this transfer of wealth from St. Peter’s to St. Paul’s that many believe we get the oft-repeated expression, “Robbing Peter to pay Paul.”

So why am I against robbing Peter (retirement account) to pay Paul (mortgage). My reasoning may surprise you, because it has nothing to do with the difference between investment returns and mortgage interest rates. Many point out, and rightly so, that for a 30-year fixed rate mortgage, you will pay less in interest than you can earn in a Roth IRA invested in a diversified portfolio of mutual funds. Add to that the tax benefit from deducting mortgage interest, and the decision becomes even more clear. But I think there is even a better rationale for leaving poor old St. Peter alone—human nature.

I love my mom; she’s the greatest. But she is not a diligent saver. If she paid off her mortgage, would she invest the monthly savings from no longer paying principal and interest (she’d still have to pay taxes and insurance)? Probably not. Frankly, if she could trust herself to invest the savings, I’d be less adamant that she not pay off the mortgage. But by keeping the mortgage, she is in effect forcing herself to save, as her retirement account continues to grow, and she reduces her mortgage balance each month.

This relates to one of my disagreements with Dave Ramsey. He suggests saving a $1,000 emergency fund, and then paying off all non-mortgage debts before saving anything else. That’s great if you follow the program, and never borrow again. Some folks may do just that, but I bet most don’t. If you don’t, you may find yourself repeating the same “borrow—pay back—borrow–pay back” cycle, with only $1,000 in the bank.

To make wise financial decisions, we must know ourselves. In the words of the Bard of Avon, “To thine own self be true, and it must follow, as the night the day, thou canst not then be false to any man.”