As people face the arduous task of repairing their flood-ravaged homes and cars that were damaged from the torrential rains and winds of Hurricanes Harvey and Irma, the costs of rebuilding keep accumulating, leaving them few options for loans.
Since the majority of consumers lacked insurance coverage for flood damage, the costs keep adding up from replacing furniture and appliances to renting another home or apartment until the costly repairs are completed.
Even homeowners in Texas and Florida who had purchased flood insurance will have to shell out extra money for rebuilding, and those without an emergency fund to tap into will have to take on additional debt. The Small Business Administration offers both homeowners and renters disaster loans ranging from 1.75% to 3.5% of up to $40,000 for property damage such as furniture, clothing, cars and appliances and up to $200,000 for repairs to the house.
Borrow from Yourself
Borrowing money or purchasing items through a credit card should be the last resort since the interest rates are often in the double digit range. While they rarely recommend this option, financial advisors and non-profit debt counselors suggest consumers to turn first to their retirement accounts as a resource.
Using money from your IRA or 401(k) account is likely a better option than asking friends or family or seeking a loan from a payday lender.
"Due to the extremely high interest rates and fees, payday and car title loans are a bad decision even under normal circumstances," said Bruce McClary, spokesperson for the National Foundation for Credit Counseling, a Washington, D.C-based non-profit organization. "While the approval process may seem quick and easy, repayment can be long and painful."
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The catch is that once you borrow money from a traditional IRA, it is permanent unlike a Roth IRA or 401(k), which allow you to repay and fund your retirement account again. Since most Americans have failed to save enough money for retirement, this choice can set you back even more. To boot, if you are not yet 59.5 years old, your IRA withdrawal could be subject to the 10% penalty tax.
Since contractors and plumbers will want a payment soon, this urgency could justify borrowing money from your own retirement fund. If you take money out of your IRA and cannot replenish it within 60 days, the proceeds will be taxed as ordinary income, plus another 10% penalty if you are under 59.5 years old. IRA loans are not revolving, and you can only borrow from your IRA once every 365 days.
"It's really not advisable, but for a short-term fix investors might consider that as an option," said Ron McCoy, a portfolio manager of the LOWS fund (Levered Options Writing Strategy) with Covestor, the online investing company, and chief investment officer at Freedom Capital Advisors in Winter Garden, Fla. "Someone should lobby Congress to pass a bill to allow people who have been affected by the storms to extend the rule to up to a year rather than the current 60 days. People shouldn't be penalized for taking out their own money in a retirement account because of a disaster. It's just wrong."
A Roth IRA could be the best place to tap cash quickly since the principal amount can be taken out at any time and without investors having to paying taxes or penalties. You also have a 60-day grace period to replace the funds.
Borrowing money in your 401(k) plan is a third option since individuals are not subject to paying additional taxes, but the rules for repayment are much stiffer, especially if you leave your job or get fired. Most plans require that former employees repay the entire loan amount within 60 to 90 days, which can be tough if you borrowed thousands of dollars.
Most 401(k) loans are structured so that the employee can borrow up to 50% of their balance or $50,000, whichever is less, said Eric Meermann, a certified financial planner (CFP), enrolled agent and vice president of Palisades Hudson Financial Group in Stamford, Conn.
"Regulations specify a five-year repayment schedule, but you can pay off the loan faster," he said.
Before taking out a loan, Meermann advises that employees, especially those facing a hardship examine their job security. If you can not pay the loan back in time, the funds are considered an early distribution which is taxable and will receive a 10% early withdrawal penalty if you are under 59.5 years old.
"A 401(k) loan can make sense if you have an expensive emergency, such as flood damage from Hurricane Harvey or Irma and it can be a better move than running up a lot of credit card debt," he said. "The interest doesn't vanish into a lender's pocket. You pay yourself and it's more like buying a bond."
Avoid borrowing from a Roth 401(k), since these accounts are funded with after-tax dollars while the account grows tax-free.
While 401(k) loans are not recommended, the "economic reality for many people impacted by natural disasters that lack adequate insurance coverage is that the 401(k) may be their only option," said Greg McBride, a chief financial analyst for Bankrate, a New York-based financial data and content company. "Just understand the long-term costs and consequences and that you are dealing a permanent setback to your retirement planning."
Borrowing from a 401(k) should be viewed as a temporary solution to pay your bills while you wait for insurance or other disaster relief funds to come through, said McClary.
"With that in mind, it is best to repay the loan as quickly as possible once insurance and disaster relief funds are received," he said.
Bank Loans Are Another Option
Consumers who have decent credit scores can also obtain a loan from their bank or credit union, but the terms of the loan will depend on their ability to repay, which could be a "challenging hurdle if your employer is not able to pay salary in the aftermath of a disaster," said McClary.
If the bank does approve a personal loan, expect that the first payment is due within 30 days.
"Be prepared to make the minimum payments on-time until you can pay the loan in full when your insurance claim and other disaster relief funds are in hand," he said.
Consumers with good credit can get unsecured personal loans with rates in the single digits, said McBride.
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