When it comes to consolidating your debt, in almost every case mathematically, but certainly from a behavior modification standpoint, you're much better off to pay those debts separate from your home. You don't want to go into the scenario of, hey, I had a steak dinner two weeks ago -- I can roll that into a home equity loan. Later, interest rates move around a little, so I refinance the home equity loan for 30 years with a fixed-rate first mortgage. Now I've got a steak dinner I've financed for 30 years. This is the average American cycle, and then we scratch our heads and wonder why we don't have any money at retirement.
“Don't lean on loans and think you can borrow your way out of debt.”
You're much better off to face your demons. In my case, it was the guy I shave with every morning. If I can get the guy in the mirror to cut up the credit card and work his way out of debt, he'll never go back. By moving debt over to a home equity loan, people tend to relax and don't face their overspending behavior.
Right, they just end up with the loan and more credit card debt.
Exactly, and it grows back and now we've got $30,000 on the house and $25,000 over here and there's a student loan that's been around so long we think it's a pet. This stuff starts to add up.
What is the worst thing you've ever heard of someone using a home equity loan for?
I think it would weave into some of the dysfunctional behavior we hear about. I can think of one a few weeks back where a 75-year-old grandmother had borrowed on her home to buy her 20-year-old grandson a car and, of course, she was broke and he had promised to pay the payments. That lasted about two months. The car has no lien on it, so he's driving around with a scot-free car and I've got Grandma over here eating off of Social Security payments and trying to keep up with a home equity loan.
When you get the dysfunctional, enabling thing going on in the family and you mix that with these financial products, you just get sad, sad results. Mix that with the heartbreak of the grandmother who was in tears and scared just because her grandson is a schlep.
People think I'm a freak because I don't believe in these loans and stuff, but I talk to these folks everyday and I guess I'm a cancer doctor and I'm starting to realize that smoking causes cancer.
Can there be a positive outcome if people take out a home equity loan and work on changing their behavior?
Yes, but it doesn't happen with enough regularity that I'm comfortable with stating that as a principle. I talked to a guy the other day who had paid off $35,000 in debt in one year. He had 20-something thousand dollars to go. He had a universal default provision in one of his credit card contracts and the company jacked his interest rate up to 30 percent a year.
He's thinking of moving the debt over to a 7 percent or 8 percent home equity loan and he's got a great credit score. Is that guy going to go bankrupt? It's probably going to work out for him because he's already demonstrated behavior change and there's a mathematical advantage for doing it. That sounds like a positive use for a home equity loan. And that's how everybody thinks that theirs is going to turn out.
A home equity loan can be a positive money move only when you've already demonstrated serious behavioral change in debt reduction and are already on that road. Then, it just becomes a little bit of a jump start.
But like I told him, 90 percent of him getting out of debt is not the interest rate; it's him continuing on his behavior track -- 3 percent of him getting out of debt might be him getting a better interest rate.
Don't lean on loans and think you can borrow your way out of debt. He hadn't. He had already emotionally, psychologically and spiritually realized he had to change himself, so he was rocking. The downside is that he put his home at risk.
If he does get the home equity loan, then he has to play through. The job has to stay intact; his wife can't go crazy and decide she's going to do cocaine. If these things don't happen, as he plays this thing out, he'll be OK. But positive outcomes are offset 90-to-1 by the bad stories and the risks that are taken.
The problem is, we all try to fix this personal finance thing with our brains. It is a brain issue, you need to use your brain. But it's also a heart issue because you need to change your behavior, and I always go back to that.
It's a tough lesson to learn, that's for sure.
It is, I learned it myself -- with a few zeroes on the end.
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