Q: I inherited a house three years ago. I thought I got good advice when I went to a financial planner, but it was only to get me onto a line of credit. I am a single full-time working mom, but have had to live off this line of credit. Now it is almost used up and I have no idea what I can possibly do once that happens? Can you please help me at all with this?
A: Generally, I think that inaction is one of the best actions that you can take when you receive an inheritance. People should take their time and evaluate their options and avoid making any rash investment or spending decisions.
If your financial planner recommended a line of credit initially, it may have been that you had high interest rate debt to pay off. If that was the case, the recommendation was a good one, saving you interest costs on your debt.
If not, you must have been in a position where you intended to spend more money than you were making in your full-time job. This is generally a recipe for disaster. The last thing I want to do is to downplay the plight of a single mother, but budgeting doesn’t discriminate, Nancy. That is, if you have more outgoing than incoming, it’s a problem no matter who you are.
I’m assuming that the inheritance of a house was not a $10,000 inheritance, but more likely a six-figure inheritance. Overspending to the tune of six figures in a three-year period is pretty serious if you maxed out a secured line of credit. In the absence of a large inheritance every few years, that trajectory is clearly not sustainable.
If the line of credit is fairly small–like under $25,000–it may be that it is an unsecured line of credit that has nothing to do with the home value. Unsecured lines of credit are simply based on your ability to repay. Banks typically won’t lend more than $25,000 unless you secure the debt with real estate equity.
A secured line of credit is up to 65% of the value of a home or if there is a mortgage on the property, 80% less the mortgage. Banks may lend less than these maximums based on your income. Secured lines of credit are literally secured by home equity and tied directly to the home from a legal perspective if you don’t pay.
If the line of credit is maxed out, you can probably go back to the bank and look to increase the line of credit if the value of the house has also increased since you inherited it. But this is a short-term fix. Selling the house might be a more appropriate choice, but since I assume you’re living in the house, no doubt that means a change in lifestyle.
When you’re going into debt, you really only have three choices. You can increase your income, decrease your expenses or sell assets. Selling the home and decreasing your expenses are likely easier than increasing your income in this case, Nancy. And hopefully selling the home will also decrease your expenses if the carrying costs are high.
Setting a budget that lines up better to your income can hopefully help you right-size your housing choice. Maybe you were spending a little more loosely than you would have otherwise after the inheritance. This is not uncommon. But in order to achieve your long-term financial goals, you need to consider short-term financial sacrifices, even if they aren’t necessarily favourable.
Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto, Ontario. He does not sell any financial products whatsoever.