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Savings Guide 2006

Savings story

  We may be saving less than ever, but money DOES buy happiness.
Home equity is not your savings account

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.

Here are some scenarios that make clear the dangers:

Bottom line: Home equity or not, it's still important to save.

Create a news alert for "savings" -- Posted: Oct. 1, 2006
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