Thinking of dipping into your home’s equity? There are a few things you should know.
There was a time, and not so long ago, that a home equity loan was tough to do. It was generally considered a risk no prudent homeowner should consider.
Where mortgage lenders used to adhere to strict guidelines that kept homeowners from getting in over their heads, the financial services industry now encourages consumers to stretch farther and farther, often to their peril.
Lenders, in an amazing shift from what’s good for homeowners to what will boost their profits, love to advise homeowners to pay off their high-rate credit-card debts with a home equity loan, curiously known as HEL. And if the attractive interest-rate isn’t enough to convince a naive borrower, they throw in magic words “cash out” to cinch the deal. “Pay off your high-interest credit-card debt, take a vacation, schedule those home improvements you’ve been dreaming of!”
There are, however, a few things they don’t tell you.
1. Equity is a concept, not a savings account. Equity, the difference between what you owe on your home and the amount you could sell it for today, is just a number. It is a theory, it is not cash in a savings account. Equity does not become cash until you sell the house and give up possession. The only way you can benefit from the equity and still live in it is to pledge the equity as collateral for a new loan. You are promising to give the cash to a lender if and when you sell. In the meantime, you agree to make monthly payments. And that plunges you into debt.
2. You’ll have a false sense of well-being. Transferring debt to a HEL can bring a kind of false sense of relief. Writing out big checks to credit-card companies from the loan proceeds feels righteous like you are repaying debt; that you have achieved $0 balances. But that’s not exactly true. You’re only moving your debt around. You can breathe again. Soon the old feelings of entitlement surface. You begin using the credit cards and before you know it they’re maxed out again. But now you have the HEL, too.
3. Spending your next down payment. Statistics say you will live in your home about seven years. That means your equity is the down payment on your next home. If you start nibbling away at it to pay for a wedding, a fancy vacation or college tuition (common reasons for HELs) you may be reducing or even eliminating your relocation options.
4. No more deductibility. In the past, homeowners who took out home equity loans were able to deduct the interest paid, up to $100,000, from their taxes. Under the new tax bill, recently signed into law by President Trump, this deduction is a thing of past. The change takes effect in Tax Year 2018, meaning this is the last year that homeowners can write off the interest they’ve paid on their HEL.
5. You could find yourself upside down. Borrowing against home equity could put you in a precarious position if the real estate bubble bursts and home values start to drop. If your mortgage plus HEL exceeds the market value, you may find yourself stuck with a home you cannot afford but cannot sell either.
6. You could lose it. People who use home equity loans tend to do it again and again and again. They get stuck in the notion that the equity is their money to do with as they please. They never figure out how to manage their money and learn the hard way that the penalty for falling behind on equity payments is losing their homes.
When it comes to home equity, here’s the best advice: Watch it but keep your hands off. The difference between what you owe and what you own may be the only appreciating asset you ever know. Guard it tenaciously. Do nothing to impede and everything to encourage its growth.
Years from now when you make the final mortgage payment and your home is all yours, you’ll be thankful you decided to think for yourself and turn your back on HEL.