The current economic challenges have accelerated the pressures on personal financial stability. As a result, the risk associated with increased expenses, loss of employment or reduction in income can lead to increased reliance on personal resources.
It is typically advised to maintain personal reserves – some call it an emergency cash fund – that total about six months of expenses. Savings accounts and money market accounts are options for this, although as a nation, our historic savings rate has been poor. In the past, many people have depended on credit lines to fund unexpected expenses or to cover living expenses after a job loss. However, dependency on credit-driven solutions after an unexpected need arises may not be financially healthy, the terms may not be favorable or credit may not be available at the time the cash is required.
A proactive solution to fund your reserves now may be to leverage your home and use loan proceeds to populate your emergency reserve. The use of debt in this way may seem counterintuitive, but there are several reasons to consider this alternative.
For example, the current market for 30-year real estate loans, the ability to lock-in long-term interest cost at 5 percent or less, sensitivity to potential future inflation and the tax deductibility of the interest create a way to fund the cushion. As the economy rebounds and incomes increase, one can always accelerate repayment of principal, which reduces the effective cost of borrowing.
There are caveats to this approach. It is critical to understand current market conditions, to limit leverage to 65 to 75 percent of your home's value, and to create a monthly housing expense that is conservative and in line with your income. Discipline will be required to manage your personal expenses.
Personal deleveraging and reducing dependency on credit to fund monthly expenses is essential to survive difficult economic conditions. In the long run, whether it is at the national, state, local, business or personal level, maintaining the proper balance of cash and debt builds personal wealth and provides stability.