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Thanks to the real estate run-up of
the past several years, you're sitting in a $500,000
home that you owe $50,000 on.
Wow, you're rich. You've got $450,000 in home equity! So what if you have no savings? You're sitting on a pile of cash.
Not so fast.
"Most Americans these days have more
money invested in their homes than all their other investments
combined, says Peter J. D'Arruda, author of "Financial
Safari."
That kind of thinking could be financially
dangerous.
"If you put too much into your house,
the bank has control over that money," D'Arruda
says. When a financial crisis hits and you need that
equity most, the bank may well not give you what's yours.
Dave
Ramsey, a radio talk show host and author of "The
Total Money Makeover," points out that the banking
industry called home equity loans "HELs" for
short. "My experience tells me they simply left
off an "L." These loans are dangerous and
an unbelievable amount of them end in foreclosure,"
he says.
Those who do draw on their home equity
may find that their home values could fall -- perhaps
lower than what they've borrowed against. If you find
yourself in a financial crisis, and can't make the payments,
you could wind up in foreclosure and lose all the "savings"
you thought you had, D'Arruda says.
Something similar happened to a couple
Ramsey calls "Ed and Sally." Their home equity
line, used for emergencies, was not renewed by their
bank after Ed lost his job, and they got behind on their
bills. This is despite their credit having been perfect
for 17 years prior to the situation. Ed and Sally had
to sell that home to avoid foreclosure.
"It is clear that many folks are
spending more than they are earning, and home equity
is a source of that excess consumption," says Richard
F. DeMong, the Virginia Bankers Professor of Bank Management
at University of Virginia's McIntire School of Commerce.
DeMong, who is an expert in home equity and mortgage
lending, notes that when a home is the primary source
of savings it won't be available during retirement as
money that one can use to live -- unless the home is
sold and a smaller, less expensive one is bought.
That option doesn't appeal to many.
Still, DeMong sees home equity loans and lines of credit as useful for home improvement projects -- since they increase the value of the home and thus the value of the home equity -- and for dealing with temporary emergencies.
"However, for longer-term emergencies,
such as a permanent disability, (home equity) is not
as helpful, since you will no longer have the equity
for retirement or other needs," he says.
Relying on your home equity as savings
can be a dangerous idea.
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Here are some scenarios that
make clear the dangers: |
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Bottom line: Home equity or not, it's
still important to save.
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