There are many good reasons to borrow on your home’s equity and smart ways to go about it, but in some cases it’s always a bad move. Here Carmen Petote, a Certified Financial Planner at Allegiance Financial Advisors in Pittsburgh, helps you avoid these borrowing pitfalls.
- Borrowing to invest.
- For the tax deduction.
- To defer debt.
- Buying from wish list.
- Bad borrowing.
1. Borrowing to invest.
Taking out a loan to invest is not a good idea. “In the late ’90s we saw a lot of that and people got really burned. But people tend to forget,” Petote says. Of course a caveat is borrowing to start or grow a business, where thoughtful consideration has gone into the expenditure and the borrower is sure the return on investment (ROI) is there. “That’s typically the way I see clients use debt to create wealth,” he says. Lesson: When the investment itch strikes, scratch with money you’ve already earned.
Lesson: When the investment itch strikes, scratch with money you’ve already earned.
2. For the tax deduction
“One of the things that drives me nuts is when people say they took out a home equity loan because they needed a deduction. What I ask them to do is put a dollar on the table and I give them back 30 cents. That’s exactly what they’re doing. Paying a dollar to get 30 cents back, 25 cents back, depending on the deduction.” He says tax deductibility should be a secondary or tertiary benefit and stresses the importance of enlisting the advice of a trusted tax professional before making decisions.
Lesson: The tax benefit is a nice perk, never a reason to spend.
3. To defer debt
Using your home equity to consolidate debt, without committing to a change in lifestyle could spell disaster. Petote says that with credit card debt the worst you could do is hurt your credit rating, but if you consolidate credit card loans into a home equity loan, your house is on the line. Consolidation to get a lower rate is a viable option only for those absolutely committed to stop using the credit cards. He cautions: “People aren’t honest with themselves. They think ‘I’m going to do it this time,’ just like they’d say ‘I’m going to lose weight,’ and on and on.” Even the best intentions can fail.
Lesson: Consolidation is not a stopgap measure. Stop spending more than you earn, no ifs, ands or buts.
4. Buying from wish list
Buying a boat with home equity creates negative wealth. “Generally you don’t build wealth by borrowing money. If you’re the lender, that’s how you build wealth,” Petote says. He opts rather to look to build wealth over a lifetime, saying that people who have lot of money typically haven’t used much debt.
Lesson: If you want it, save for it.
5. Borrow using a balloon or interest-only loans
Interest-only loans or loans with balloon payments are generally marketed to people who are looking to buy more home than they can afford, says Petote. He warns: “If you’re stretching it and only paying interest, when you go to refinance and throw principal in there too, you will really be in big trouble. Or if you don’t have a strong cash flow or money available, you will run into problems when that balloons.”
Lesson: Pay on principal. It’s in your best interest.
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