Thinking of tapping into the equity in your home? There was a time, and not too long ago, that a home equity loan, or HEL, was hard to get. It was generally considered a risk that no prudent owner should consider.
While mortgage lenders used to adhere to strict guidelines that kept homeowners from getting in over their heads, the financial services industry is now encouraging consumers to stretch further and further, often at their own risk. and perils. There are some things they don’t tell you though.
1. Equity is a concept, not a savings account. Equity, the difference between what you owe on your home and how much you could sell right now, is just a number. It’s a theory. It’s not cash in a savings account. Equity only becomes money when you sell the house and give up possession of it. The only way to benefit from the equity and continue to live in it is to pledge the equity as collateral for a new loan. You promise to give the money to a lender if and when you sell. In the meantime, you agree to make monthly payments. And that puts you in debt.
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2. You will have a false sense of well-being. Transferring a debt to a HEL can bring a false sense of relief. Writing big checks to the credit card companies from the loan proceeds just seems like you’re paying off a debt and you’ve reached a zero dollar balance on your unsecured debt. But that’s not entirely true. You’re just moving your debt. You can breathe. And old feelings of entitlement surface. You start using credit cards again, and before you know it, the cards are gone again. But now you also have the HEL.
3. It can be more expensive. This HEL with lower interest could easily end up costing more than credit card debt with higher interest. Comparing credit card debt at 16.99% to HEL at 7.25% may not be as straightforward as it seems.
4. Spend your next installment. Statistics indicate that you will live in your home for about seven years. This means your equity is the down payment on your next home. If you start chipping away at it to pay for a wedding, a luxury vacation, or college tuition (common reasons for HELs), you may be reducing or eliminating your relocation options.
5. More deductibility. In the past, homeowners who took out home equity loans could deduct up to $100,000 of the loan interest from their taxes. Under a US tax bill signed into law by President Trump, this deduction is a thing of the past. The change took effect in 2018, meaning the 2017 tax year was the last year homeowners could deduct interest paid on a home equity loan.
6. You might end up upside down. Borrowing against your home’s equity could put you in a precarious position if the housing bubble bursts and home values start to fall. If your mortgage and HEL together exceed market value, you may end up with a home you can’t afford or sell.
7. You could lose it. People who use home equity loans tend to use them again and again and again. They get stuck in the idea that equity is their money that they can do with what they want. They never know how to manage their money and learn the hard way that the penalty for falling behind on equity payments is losing their home.
When it comes to your home equity, here’s the best advice: watch it, but don’t touch anything. The difference between what you owe and what you own may be the only valuable asset you know. Hold it tenaciously. Do nothing to hinder and everything to promote its growth.
Years from now, when you make the final mortgage payment and your home is yours, you’ll be grateful that you decided to think for yourself and turn your back on HEL.
Mary Hunt, founder of www.EverydayCheapskate.com, writes this column for Creators Syndicate. Submit comments, advice or questions on its website. She will respond to topics of general interest through this column, but letters cannot be answered individually.