Keep 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.
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 7.23 percent home equity loan
to stretch the payments out over 180 months and payments go down to $365. Total
payments will be $65,700 ($365 x 180) and total interest, $25,700 ($65,700 minus
$40,000); you'll pay $3,700 more interest with the home equity loan. If you're
lucky, the tax deduction will compensate for the extra $3,700, 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.
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.
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.
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
- Spend less than you earn, and save
- Resolve to be debt free, and lay out a strategy
to make it happen. Read the "Push
payment plan" for some tips.
- 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.
For more hints on achieving financial freedom, read
timeless tips for women." The tips work for men, too.
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.