Cons of using home equity to consolidate
your cotton-pickin' paws off your nest egg.
Using home equity to pay off bills and make major purchases always
looks good on paper; that's why so many folks are doing it. How can you argue
with lower monthly payments, tax-deductible interest and no more credit card
debt? It's easy when you're the Dollar Diva.
Lower monthly payments
If you're a typical American consumer, you have too much high-interest debt,
and it's costing a bundle to service it. When a lender offers a chance to lower
those monthly payments with a low-interest, home equity loan or a cash-out refinancing,
it can feel like manna from heaven. But don't kid yourself; no one's passing
out free lunches. When you tap home equity to pay off bills, you kiss off those
high monthly credit card payments, but you don't kiss off the debt.
The lower monthly payment makes the debt look harmless. Look closer
and behold the same old wolf; he's just decked out in grandma's bonnet. Even
though the interest rate is less and the monthly payments are low, you usually
end up paying more over the long run because the payments are stretched out
over a longer period.
When debtors use home equity to pay off their bills, they usually
swear to God they'll never carry a credit card balance again; but they forget
to change their spending habits, and they forget to save for emergencies and
big-ticket items. When the car needs a new transmission, or they "need"
a vacation, the plastic get resurrected and the debt cycle resumes.
Tax-deductible interest is the war cry lenders use to prod unwary homeowners
into using their precious home equity to fund major purchases and pay off debt.
It sounds good until you start running the numbers. Let's pretend you have $40,000
in 18 percent credit card debt; your current monthly payment is $1,000. Continue
the $1,000 payments, and the debt is history in 62 months. Total payments will
be $62,000 ($1,000 x 62) and total interest will be $22,000 ($62,000 minus $40,000).
Use a 9 percent home equity loan to stretch the payments out over
180 months and payments go down to $406. Total payments will be $73,100 ($406
x 180) and total interest, $33,100 ($73,100 minus $40,000); you'll pay $11,100
more interest with the home equity loan. If you're lucky, the tax deduction
will compensate for the extra $11,100, but don't count on it. The lenders are
the only ones who can bank on making big bucks on home equity loans; that's
why they spend big bucks marketing them.
No more credit card debt
Tapping home equity makes it easy to get rid of credit card debt, but that state
of bliss is usually fleeting. Why do folks rack up so much credit card debt
in the first place? Could they be living beyond their means? Most folks who
use debt to get rid of debt forget to change their negative spending habits
and end up deeper and deeper in the hole.
Home equity loans can be expensive
Home equity is something to cherish and preserve, not deplete. Here's what no
one tells you when you sign off on that home equity loan:
- Home equity is a time-proven way to accumulate wealth and provide
a sense of security; when you tap it to pay off bills, you become poorer.
- Use home equity as a money tree and you could end up paying
private mortgage insurance (PMI) forever.
- Credit card companies can't foreclose on your home if you run
into financial difficulties. But home equity loans and cash-out refinancings
are debts that are secured by your home. If you can't make the payments, you
risk living in a corrugated box.
- How about those loan origination fees and prepayment penalties?
For most folks, the road to getting out of debt and achieving financial independence
is paved with discipline and belt tightening, not more debt. Debt paves the
road to bankruptcy court. Here are some tips to help you get on the high road
-- to financial freedom:
- Spend less than you earn, and save the difference.
- Resolve to be debt free, and lay out a strategy to make it
- Invest in yourself -- you are a money making machine; the more
money you make now, the quicker you'll achieve financial independence.
- Keep your cotton pickin' paws off the equity in your home.
As a general rule, tapping home equity is a no-no; but where is it written you
can never break a rule? If you give birth to triplets and need another bedroom
added to your home, or the three of them get into Harvard in 2019, you might
consider home equity to get you over the hump. But only if you are in excellent
financial health, with no other debt, money in the bank for emergencies and
the discipline and resources to quickly pay back what you draw out.
-- Posted: Jan. 9, 2003