Now that home values have risen, some people are asking about taking out a Home Equity Line of Credit, a type of second mortgage.
In general, I am against home owners taking out a HELOC. It wasn’t that long ago that thousands of home owners who had spent their precious equity on a HELOC found themselves in foreclosure. And consequently, with severely damaged credit.
Now is not the time to make that same mistake all over again.
Of course, that doesn’t stop the greedy banks from pushing this product.
I will allow that there is the rare valid reason to take out a HELOC, such as when you want to increase your wealth in real estate by purchasing another home or when you have a failed roof.
On the other hand, using your property as a piggy bank is a bad idea.
Reasons NOT to Take Out a HELOC
I am opposed to increasing the debt on your primary residence for the following purposes.
1) Home improvements: If you can’t afford it, wait until you save the cash. Why? Because a $50,000 remodel does not increase your home value by $50,000. You come out behind financially.
On top of that, you pay back more than $50,000 due to the high interest rates.
2) Consolidating debt: This is a big no! You never roll plastic (credit card debt) into your precious real estate. This is one of the worst financial mistakes home owners made in the past. Don’t repeat it.
If you get your credit card shut down, it’s no big deal. If you get kicked out of your house, it’s a very big deal.
3) Education: Take out a student loan if needed. Never pay for school with your house. That goes double for your kids’ education!
4) Care-taking: I believe in compassion and generosity, but you do not go into debt and spend your equity in order to take care of someone’s medical bills, dying wish, or funeral expenses.
5) Vacation: To the loan officer who suggests this, you reply, “No, I am not stupid.”
6) Open for a Safety Net: A HELOC does not make a good safety net. It is quite the opposite. A bank can reduce or shut down a HELOC at any time. The interest rate can go up, often with a lifetime cap of 19%. This does not provide you with financial safety. Create a savings account for safety. Find a secondary source of income for safety.
A Little-Known Fact and a Warning
Most home owners don’t know that if they have a HELOC (or any type of second mortgage that was opened after purchasing the home) and then want to refinance, that HELOC will put them into a higher credit risk category — even if they have perfect credit and a 800 score.
That’s right, you will pay a higher interest rate simply for having a HELOC when you refinance.
We live in an age of instant gratification and entitlement. Listen folks: you do not “need” granite counter tops or a bathroom makeover. Sure, those things are wonderful to have, but exercise patience and save your money until you can actually afford to purchase them.