Debt Management Basics
debt
Downside of home equity loans

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 is 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.

Pay more over time

The lower monthly payment makes the debt look harmless. 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.

Change your habits

When debtors use home equity to pay off their bills, they usually swear 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.

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 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.

 

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