A New Kind of Layoff Insurance

By Jean Chatzky Sunday, Dec. 16, 2001
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    Though the recession's bloodletting diminished last month, to about 180,000 layoffs--down 25% from the record set in September--it continues to make news. Last week American Express announced it was shedding more than 5,500 employees--on top of the 7,700 it cut earlier in the year. Similar dire notices came last week in industries as diverse as health insurance (Aetna), semiconductors (Applied Materials) and automotive products (Delphi). Fear of job loss is spreading among workers in retailing, which is expected to downsize sharply in 2002. Even the booming health-care sector isn't safe if the recession continues into the second half of next year, says John Challenger, CEO of the outplacement firm Challenger Gray & Christmas.

    What can you do to prepare? Most financial planners advise that you set aside, in a savings or money-market account, an emergency cushion of three months' to six months' salary. (Last month the typical laid-off worker took 14.5 weeks to find a new job.) Unfortunately many of us have far too little cash in our emergency fund. A Fidelity Investments survey released this month shows that 2 out of 5 families--some 71 million Americans in all--haven't scraped together even a three-month cushion. In a pinch, those surveyed said, they would borrow from friends and family, sell investments and raid their tax-advantaged ira and 401(k) retirement accounts.

    But you may have another option: your house. I'm not suggesting you put it on the market. Instead, find out whether your home's appreciation and your principal payments on your mortgage have left you with valuable equity that you could tap in an emergency.

    The best way to do this is with a home-equity line of credit. Lines of credit, like home-equity loans, are second mortgages with a typical 10-year term that are secured with a lien, or claim, against your house. When you receive a home-equity loan, the lender cuts you a big check and requires that you begin repaying the loan immediately, with interest. Not so with lines of credit. You draw down only what you need, when you need it--and only then do you begin paying the lender. For that reason, says Keith Gumbinger, vice president at mortgage information publisher HSH.com , lines of credit make great emergency cushions. "If you never lose your job and never borrow any money, there's never anything to pay," he says.

    That isn't all the good news. Rates on home-equity lines of credit, which typically move with the prime interest rate charged to the most credit-worthy business borrowers, are at record lows. As of last week, the average line of credit was 5.96% with no closing costs, according to HSH's survey of 1,100 lenders--and was expected to fall further, thanks to the Federal Reserve's quarter-point reduction in short-term interest rates last week.

    As with any purchase, you will get the best deal by shopping around. Don't just read the ads in your local paper, Gumbinger cautions. Smaller institutions such as credit unions and savings and loan associations often have the best rates, in part because they don't spend much on advertising and instead rely on word of mouth to bring customers to their doors. In Albany, N.Y., for example, megabank Fleet Boston is offering a rate of prime plus 1.25%, while tiny Troy Savings is offering prime minus 1% (currently 3.75%) for the first six months, then prime plus zero. Generally, interest on the first $100,000 of a home-equity line of credit is tax deductible as long as your total mortgage debt doesn't exceed the value of your house.

    Of course, you will be far more likely to get approved for a line of credit if you apply while you are still drawing a paycheck. You may have enough of a window from the time the pink slips go out till the time you stop getting paid, but it's wiser to arrange your credit line before you need it.

    (If you are already out of work and want to draw money out of your home, ask your current lender about a streamlined refinancing of your mortgage that could allow you to lower your rate or extend your term without providing new documentation. Either route will reduce your monthly payment.)

    Is there any downside to taking out a line of credit that you never use? Not really. Some lenders charge annual "nonusage" fees of $50 to $100 if you take out a line of credit and let the checks sit in a drawer. Even then, says Gumbinger, "It sounds like pretty inexpensive insurance to me."

    Jean Chatzky is editor-at-large for MONEY magazine. You can send her an e-mail at moneytalk@moneymail.com