Where can I turn when my household income runs dry?

Where Can I Turn When My Household Income Runs Dry?

Whether it’s the loss of a job, unexpected medical expenses, home repairs or any other reduction in income, anyone in a financial bind has a variety of resources they can turn to—particularly if they already have a bit of equity to borrow against.

Options include – borrowing from a life insurance policy or a 401(k) plan; tapping a home equity loan; an ordinary refinancing; or getting a reverse mortgage.

Of course no discussion of these issues would be complete without first mentioning the importance of financial planning to try and avoid this scenario. Each of these options comes with potential drawbacks to the point where some financial analysts argue for just avoiding them altogether.

Additional sources for information on reverse mortgages and financial planning in general.

The Department of Housing and Urban Development’s information page on Home Equity Conversion Mortgages
click here.

HUD’s HECM counseling agencies

Find a HUD-approved reverse mortgage counselor at this address or by calling 800-569-4287.
click here.

Top 10 things to know if you’re interested in a reverse mortgage
click here.

10 things you should know about reverse mortgages
click here.

Frequently asked questions on reverse mortgages, from the National Reverse Mortgages Lenders Association
click here.

Financial Planning Association

Information on investing and finding a financial planner
click here.

Certified Financial Planner Board of Standards

Consumer guides on financial planning and resources for finding a financial planner
click here.

The National Association of Personal Financial Advisors

Includes a “field guide” on finding and evaluating a financial advisor
click here.

Of course no discussion of these issues would be complete without first mentioning the importance of financial planning to try and avoid this scenario. Each of these options comes with potential drawbacks to the point where some financial analysts argue for just avoiding them altogether.

Bill Palmer, senior financial advisor and a Certified Financial Planner with Win Wealth Management in Denver, Colo. says everyone should have about six months of living expenses set aside in an emergency fund which they can earn interest on, rather than borrowing when they get in a pinch.

“These are solutions for people who are not planning so why not better serve those people by encouraging them to plan and to save and to live within their means, or better yet below their means so that they can save. It’s all about striking a balance between consuming today and starving tomorrow,” Palmer says. “Interest is a reduction in your total cash flow so if you don’t have to pay interest in the grand scheme you’re much better off.”

Palmer suggests keeping a reserve fund in a four-year Certificate of Deposit to earn interest, then pay whatever penalty might arise from having to draw on that money in an emergency.

Yet not everyone is willing or perhaps able to follow that advice. Anyone reading this article might be at the point where they need resources now. That’s why we’ll take a look at each of these options and consider the issues surrounding all of them.

“Any resource can be a tool so long as it’s wisely used. It doesn’t matter whether it’s a reverse mortgage or a home equity credit line or you borrow cash value from your life insurance policy or 401(k) plans,” says Neil Van Zutphen, president of Delta Ventures and a Certified Financial Planner in Mesa, Ariz. “You have to think of each as its own tool and understand the pros and cons of each of the tools.”

He says the first step, before even considering these options, is to cut back on expenses and save as much as possible. While tapping these resources can help those in a bind, they can easily let someone get lulled into a false sense of financial security.

“They spend at a normal level when they should be saying to themselves holy smokes I need to really ratchet this down and spend the least amount possible so that we can preserve and conserve our capital for as long as possible,” Van Zutphen says.


At a time when interest rates are at such low levels, a simple refinancing could reduce a mortgage payment and provide extra cash in a homeowner’s budget. Unfortunately, a weakness in the housing market means anyone who bought a house within the past few years is probably underwater as their home could be worth far less than the mortgage they have on it.

“If you have at least 20 percent equity in your home you ought to have a good opportunity to refinance, if you have good credit, and obtain historic low interest rates,” says Samuel Tamkin, a Chicago-based real estate attorney, real estate expert and columnist for ThinkGlink.com.

“Recently I talked to someone who said they were offered a 2 ¾ interest rate on a 15-year mortgage. That interest rate seemed so low to me that it was almost free money,” Tamkin says.

While some homeowners might be tempted to get extra cash from refinancing by borrowing more than they have in their existing mortgage, Tamkin says this could be difficult unless a home’s value is substantially higher than the new mortgage amount.

Palmer says refinancing would be an option for those whose loan to value ratio is at 80 percent, although he warns against pulling excess capital out of a mortgage as most people aren’t responsible enough to use that money wisely.  He suggests putting money into an index fund rather than trying to beat the markets.

“For those who have discipline then I’m okay with having a home mortgage that you take cash out of when you refinance if you immediately invest it in a long-term investment plan and you don’t gamble it on speculative investments,” Palmer says. That’s the only time when I would encourage somebody to take out cash, but the rule of thumb is if the rate of the debt cost you less than the highly probable expected return, not an eyes in the sky end of the rainbow expected return, but something pragmatic and realistic.”

Untapped financial resources and life insurance

Home equity loans

Home equity loans and Home Equity Lines of Credit are basically second mortgages of a different name. They allow a homeowner to borrow against the equity in their home at rates lower than other means of borrowing, such as a credit card. (see sidebar)

A home-equity loan provides a one lump payment at a fixed rate and is generally used for a set amount of money for specific purpose, such as repairing a home or building an addition.

A HELOC comes with a variable interest rate that usually tracks the prime lending rate, plus a few points. A borrower gets special checks they can draw on at any time and are often used as an emergency fund.

The HELOC doesn’t accrue interest charges until the line of credit is actually tapped by the borrower, so it can function as a backup financial plan in case of emergency. A HELOC can be revoked or altered at any time by the bank for various reasons, such as a substantial decline in a home’s value or a change in the homeowner’s finances.

“It’s only there in the event of a true emergency. If you lose your job or both of you lose your jobs,” Van Zutphen says. “You try not to tap into it all at once, you just use it as you can and then try to pay it back as quickly as possible.”

Interest rates are low enough to make a home equity loan affordable, Tamkin says, although it’s unlikely that anyone who bought a home within the past seven years or so would have enough equity in their home to borrow against.

“Some markets you may have seen prices go back to around the year 2000 but if you bought in 1994 and you’ve been in your home almost 20 years, you may still have a substantial amount of equity in your home, particularly if when you refinanced you only refinanced prior balances and didn’t take additional money out,” Tamkin says.

Palmer says the best use of a HELOC is to have one on hold with a bank, but only as a backup resource to an emergency fund that can be used after a six-month savings reserve has been depleted.

Tapping a 401(k)

Perhaps the biggest upside to borrowing against a 401(k) plan is the ease at which it is done. Whereas borrowing from a bank can involve a lengthy credit application, tapping 401(k) funds is a matter of filling out a form and paying what’s usually a nominal fee, although not all plans allow this.

Reverse mortgage costs:
There are several costs and fees involved in a reversible mortgage, otherwise known as a Home Equity Conversion Mortgage. They can be paid out of pocket or covered by the loan itself.

Mortgage Insurance Premium for mortgage insurance, charged at closing, based on the lesser of the home’s appraised value, the mortgage limit of $625,000 or the sales price:
2% of the loan for a HECM Standard
.01% for a HECM Saver
Also charged an annual MIP of 1.25% of the mortgage balance

Third party charges:
Closing costs from third parties can include an appraisal, title search and insurance, surveys, inspections, recording fees, mortgage taxes, credit checks and other fees.

Origination fee:
A lender can charge a HECM origination fee up to $2,500 if your home is valued at less than $125,000. If your home is valued at more than $125,000 lenders can charge 2% of the first $200,000 of your home’s value plus 1% of the amount over $200,000. HECM origination fees are capped at $6,000.

Interest rate:
You can choose an adjustable interest rate or a fixed rate. If you choose an adjustable interest rate, you may choose to have the interest rate adjust monthly or annually. Lenders may not adjust annually adjusted HECMs by more than 2 percentage points per year and not by more than 5 total percentage points over the life of the loan. FHA does not require interest rate caps on monthly adjusted HECMs.

Service fee:
Lenders may charge a monthly service fee of no more than $30 if the loan has an annually adjusting interest rate and $35 if the interest rate adjusts monthly. At loan origination, the lender sets aside the service fee and deducts the fee from your available funds. Each month the monthly service fee is added to your loan balance.

Source: U.S. Dept. of Housing and Urban Development
More information at: click here.

Most of these loans must be paid off within five years, although those borrowing for a down payment on a house will have longer than that depending on their plan. Craig Copeland, senior research associate at the Employee Benefit Research Institute, says such loans usually have a low interest rate and the money goes right back into the borrower’s own account so they’re essentially paying interest to themselves.

He says another difference between borrowing from a 401(k) plan vs. a bank is that a 401(k) loan doesn’t require the borrower’s home to be used as collateral so there’s no risk of losing it if the loan isn’t paid back.

A 401(k) loan isn’t entirely without a hitch, as a borrower would have to pay taxes on whatever funds they don’t pay back as well as a $10,000 fine. A 401(k) loan would also have to be repaid in full if the borrower leaves their job for any reason.

“You may be a better investment, particularly when the stock market is down. It kind of depends upon the timing of your loan versus markets, now that’s going to be really hard to do if you decide to take out a loan based on the markets because it is all based on timing, but in a way you are giving yourself guaranteed income back by repaying the loan,” Copeland says.

The Internal Revenue Service does allow withdrawals from 401(k) plans without the $10,000 penalty under certain hardship cases, although income taxes would still have to be paid on what was taken out of the plan.

The IRS says hardship distributions are for “an immediate and heavy financial need of the employee” including their spouse, dependents or beneficiary.

Circumstances include medical expenses, tuition, preventing foreclosure on a principal residence, certain home repairs and burial and funeral expenses. A distribution is not considered necessary if the employee has other resources available such as commercial loans and the assets of a spouse and minor children, unless the child’s assets are held in an irrevocable trust.

Given the unpredictability of the financial markets, Palmer does not recommend borrowing from a 401(k) plan. He says it’s impossible to know for sure when a bear market is happening, but the market will generally increase over time so the chance that a 401(k) loan will hurt investment growth is high.

“Oftentimes there’s an interest rate you’re paying yourself but it’s probably not what your expected return would have been on the investment that you’re taking the money out of,” Palmer says. “What I know is 70 percent of the time, plus or minus, the market goes up. So if I invest in the market my odds of success are very high and since I don’t know if it’s a bull market or a bear market if I put my money in the odds are with me.”

Van Zutphen says he borrowed from his own 401(k) plan as part of a down payment to buy out his business partner. At the time he had refinanced his mortgage and hadn’t reestablished a HELOC, but thought buying out his partner was a suitable investment opportunity.

“In this marketplace if you’re buying some real estate maybe the value of the real estate is a really great buy and an investment opportunity as well. As long as you’re gainfully employed and you can pay those things back then it’s a great tool,” Van Zutphen says. “If you’re taking it out of the plan and you’re buying something then you’re using it as an investment tool to buy a potential appreciating asset, and then you just have to weigh the pros and cons of the interest charged by the plan and the cost of funds that you could get otherwise for the down payment.”

untapped financial resources and life insurance policies

Borrowing from life insurance

Unlike term life insurance, which is for a set period of time, whole life, universal life and variable life insurance policies come with a cash benefit that can be tapped as a resource. These plans are not only more expensive than term life insurance, their premiums would steadily increase over time if not for the cash value component.

To avoid such an increases, whole life and other such policies have fixed premiums and part of the money received by the insurance company is invested as a cash value that is attached to the policy. As the cash value grows over time, the company draws on those funds to offset the increasing cost of maintaining the policy.

It’s sort of like a savings account or a mutual fund that helps pay part of the premiums later on in life. The cash value can be borrowed from, provided it has reached a sufficient level.

Just like borrowing from a 401(k) plan, Tamkin says borrowing from a life insurance policy can hurt someone’s investment prospects even if the money is paid back.

“It may cause your investment strategy to change and you may not get the same benefit that you would have if you had invested that money in whatever the plan was going to invest in,” Tamkin says. “If your plan was to have a whole policy to save money and defer income, borrowing against it is going to reduce the benefits that you’ll accrue in the future. That may not be a wise investment decision.”

Van Zutphen says he would consider borrowing from a life insurance plan before he would opt for a home equity loan or a HELOC and he’s borrowed from his own life insurance plan before, yet it would be risky to borrow too much from the cash value as it could put a policy at risk.

“If you borrowed all the cash out of your policy the premiums you pay would be insufficient to keep the policy active,” Van Zutphen says. “The cash that was going to be used to help maintain the cost of the policy, benefits and everything else level or at a reasonable price would change because the cash is no longer there. The insurance company doesn’t get to use that cash and since they don’t get to use the cash, it’s likely that the policy will lapse.”

Palmer has a different approach entirely as he doesn’t think whole life policies are even necessary. He suggests people start with term life insurance when they’re younger but then self-insure themselves by taking what they would’ve spent on a whole life policy and invest the money instead.

“Insurance is absolutely essential but it’s for a defined quantifiable need. You have to have an insurable interest,” Palmer says. “Once your net worth gets high enough to support those that depend on you, you don’t need life insurance.”

Rather than thinking of a whole life or a variable policy as an investment, Palmer suggests keeping a balanced portfolio instead because a life insurance policy cannot beat the returns offered by an index fund.

“Generally speaking you should buy insurance as insurance and investments as investments because as soon as you mix the two something is compromised,” Palmer says. “It’s like two and two end up equaling three.”

hidden resources for extra money which includes life insurance

Reverse Mortgage

In a reverse mortgage, also known as a Home Equity Conversion Mortgage, a homeowner is given a sum of money from a bank and when they die or move out of the house it’s sold and the proceeds pay off the loan. Interest is charged against the loan, just like a traditional mortgage that accrues over time.

Most of them are non-recourse loans, which means the borrower or their descendents will never owe more than the amount that was borrowed—as long as the home is sold in an “arms length transaction” at market value to a third party.

For example, if a homeowner dies owing $100,000 on a reverse mortgage and the home is sold for $120,000 the estate would be receive $20,000 after the loan is paid off. If the house sells for less than $100,000 the estate would receive nothing from the sale but would not owe any additional funds.

Reverse mortgages are available to those individuals who are 62 and older. If the property is jointly held, then both owners must be of the required age. The amount available for borrowing depends on the youngest homeowner’s age and which kind of loan they obtain. The borrowable limit increases with the owner’s age.

A married couple seeking a reverse mortgage might be tempted to remove the younger partner’s name from the home’s ownership in order to qualify for the largest sum possible, yet this is not an option to be taken lightly.

Home Equity Loans and Home Equity Lines of Credit

A home equity loan acts like a second mortgage, so the owner must have sufficient equity in the home to borrow against. This is not an option for properties that are “under water” (worth less than the outstanding mortgage).

Here are the basics:

  • Borrow up to $100,000 and deduct interest from tax returns
  • Generally 5 to 25 years in duration
  • Must be paid off in full at the end or if the home is sold
  • Lower interest rate than credit cards and other forms of credit
  • Typically used for major items like education, upgrading home or medical bills
  • Usually non-recourse loans—borrower’s liability limited to only the asset/collateral.
  • Borrowing limit often set at a percentage of home’s appraised value (say 75%), minus balance owed on the existing mortgage.
  • May have a “balloon payment” with balance paid off at the end of term
  • If home is your principal dwelling, you have three days after opening account to close it at no cost in fees

There are two kinds of home equity loans, fixed rates and a Home Equity Line of Credit:

Fixed rate:

  • · Single, lump sum payment to the borrower
  • · Payments and interest are set in stone
  • · Good if need a set amount of money for a specific purpose (such as building an addition)

Home Equity Lines of Credit:

  • · Variable interest rate
  • · May have minimum monthly payment (interest only), which changes according to the interest rate. It’s usually indexed to the prime rate, plus a points margin, and must have a cap on the total increase for the life of the loan.
  • · Banks may freeze or alter the loan if the property sees a significant decline in value, or if there’s a change in your ability to pay it back.
  • · Usually get special checks to draw on, or a “credit card”
  • · May have limitations on use, such as $300 min per draw
  • · Can access at any time and use as a reserve or emergency fund


  • · Some lenders waive some or all of closing costs
  • · Appraisal, application, closing costs, attorney fees, taxes, property and title insurance.
  • · Points based on a percentage of the entire loan
  • · Annual loan fee

For more information, see the Federal Reserve’s “What you should know about Home Equity Lines of Credit.” Click here.

Lori Trawinski, senior strategic policy advisor in the American Association of Retired Person’s Public Policy Institute, points out that if only one name is on the reverse mortgage, and if that person dies first or has to move out of the home, the surviving spouse would have to either give up the house or pay off the loan in full.

“This leads to problems because in the event of the death of the person who is on the mortgage note the loan then becomes due and payable,” Trawinski says. “It’s a risky strategy and historically some people have run into some trouble with that as in non-borrowing spouses have ended up getting a due and payable notice for the loan.”

For this reason, the Department of Housing and Urban Development issued a requirement in August 2011 that couples seeking a reverse mortgage would have to meet with a HUD-approved counselor before obtaining a loan.

There are two options available for reverse mortgages. A HECAM standard loan allows the most funds to be borrowed but with more expensive fees. A HECAM SAVER loan offers lower fees but with a reduced borrowing limit (see sidebar). Trawinski says the saver option is good for those needing loans for a shorter amount of time, because they come with lower fees.

Regardless of which loan is selected, borrowers are required to maintain the property, pay property taxes and keep the home fully insured. Failing to do so can put the loan into foreclosure. They must also remain in the home or surrender it to the bank if they leave the residence for more than a year.

“You’re not gaining lifetime income, you’re gaining income for as long as you live in the home,” Trawinski says. “The loans are designed to be in place for as long as people are permanent residents of their home, so if they sell it or die or move out permanently the loan needs to be repaid.”

Loan proceeds can be given to the borrower in a variety of ways: a lump sum, a line of credit or a monthly payment for a set period of time. Trawinski says seniors often turn to a reverse mortgage as a way of paying off their regular mortgage or if they need work done on the home but don’t have enough income to quality for a home equity loan.

“In these cases sometimes a reverse mortgage can be the answer because you can borrow the money and you don’t have to make repayments,” Trawinski says. “Sometimes these loans are the only option for people who need some funds.”

Among all of these financing options, Palmer calls a reverse mortgage is the “the worst of the bunch” because of the fees involved. He suggests homeowners consider selling their house and use the cash to move into a small apartment instead, rather than paying 3 percent to 6 percent in fees.

Tamkin says someone considering a reverse mortgage ought to have considerable equity in their home and may want to consider other options first, as he estimates a $50,000 reverse mortgage loan could cost the borrower $6,000 in fees.

A standard refinancing or a new mortgage might be a better option for some, as Van Zutphen points out that it would also provide a sum of money that the borrower can use for living expenses. A reverse mortgage, on the other hand, can pay off an existing mortgage, provide a cash payout to the homeowner and eliminate the stress of making a monthly mortgage payment.

“To me that’s kind of a neat way of using a reverse mortgage as a tool, assuming the client or couple wants to stay in that home their whole lives and aren’t looking at the home equity as an additional tool that they’ll use later in life,” Van Zutphen says.