What to Do With the Severance

Mark is getting a severance package from his company and has a second mortgage on his house. Should he hold on to the severance, borrow from a relative, or pay off the second mortgage?

QUESTION: Mark in Portland lost his job last week. He’s getting a severance package from his company and has a second mortgage on his house. The severance will be about $10,000, and Mark has enough in savings to make up the difference to $15,000 to pay off the second mortgage. Should he hold on to the severance, borrow from a relative, or pay off the second mortgage?

ANSWER: You are in the middle of an emergency. When you’re in the middle of an emergency, you usually don’t pay down debt—you preserve and reserve cash to make sure we make it through the emergency. What I would do is temporarily add the $10,000 to your emergency fund until you get the job.

Let’s pretend you got a job next week, and you earn what you used to earn, or more. In a sense, that severance pay becomes a signing bonus. Now we have an extra $10,000 to accelerate our financial plan. Then you would use it to reduce debt if you have it, which you do.

The first goal is $1,000 cash in the bank. The second goal is to be debt-free except the house. The third goal is to have a fully funded emergency fund of three to six months of expenses. You use your signing bonus to accelerate those processes. But in the meantime, we’re in the middle of an emergency. You may need that money just to keep the doors open.

If you have $30,000 in savings to go along with the severance, you’ve got almost half a year’s income right there. When you get the next job, write a check that day and pay off the mortgage. I wouldn’t money borrow from a relative, ever. Just write a check and be done with it.

Then if your emergency fund is a little pinched, you are debt-free except the house at that point, then clear the second mortgage and replenish your emergency fund at that point. Also, since that will make you less desperate, you’ll interview better. Go out and land something really fast so you can use this money.