Rule No. 1 of Financial Safety
Recently, a friend asked me to lend an ear to a business partner's money troubles, his hope being that I could offer some solution to get his partner, Cal, out of a financial jam.
Cal is past what most folks consider retirement age but still works and owns his own business. This makes him older and more experienced than most. His plan was to eventually move to a warmer climate and retire, so he bought a second home in Nevada with a down payment of almost 30 percent. He figured that to do it, he would take out a bridge loan against his primary home, which is located in the Northeast. Now with a mortgage on his second home and a bridge loan on his primary home, the problem is that the bridge loan is due in a few weeks and the lender was not willing to extend it. Times being what they are, no other lender was willing to refinance the bridge loan because it exceeded the conforming loan limit. Being self-employed, Cal has little documentation to show meaningful income other than Social Security retirement benefits. He has no additional assets other than significant equity in real estate and inventory of his business -- neither which is very liquid in the current economy.
After I listened to Cal tell his story, it became clear to me that despite his age and experience, Cal failed to keep in mind the No. 1 objective of successful financial planning: always keep your financial options open. Over his working life, he used all his spare cash flow to pay down his mortgage (not necessarily a bad thing), and with what little he had saved (not a good thing) he bought a second home before he sold the first (never a good thing). As a result of his style of financial planning, he has a high net worth (mostly in the form of illiquid equity in real estate and business inventory), but he has no cash reserves and no liquid financial assets saved.
Now that the game has changed, Cal's options are limited: Sell the property in a distressed market, or wait it out with the bank to see if they move in to foreclose on his loan. I recommended that he lay all of his cards on the table and have a long and candid conversation with his lender. Cal has one thing going for him: He has enough income to keep current on his loan payments. My bet is that the lender, a local bank, does not want both a nonperforming loan and a property on their balance sheet. If they tried to sell it as a REO property, they would probably not get enough to pay off the loan. I advised that if Cal could convince the bank that he could stay current on the bridge loan (and he has not been late with a payment yet), then the bank should be willing to extend the loan on a month-to-month basis. I also suggested that Cal would need to list the property for sale and aggressively discount the price to show that he was willing to take reasonable steps towards ending this situation. That's what he did, and for now the bank is going along with it.
My advice to folks who are considering a big financial transaction such as a real-estate purchase is to always think about your exit strategy and consider your balance sheet and cash flow. Your whole financial situation must include sufficient liquidity and the income to support the ongoing expenses of the property. Also, never use a temporary loan -- such as an adjustable rate loan or a bridge loan -- unless you have the financial assets to restructure it if needed. Do this and you'll have my blessing to move ahead. Do otherwise, and you could end up in a jam with no good financial options.
