I know I have talked many times about mortgages. But I have never spoken about home equity loans.
A home equity loan (HELOC) is a loan against the principal on your home. Some people take this type of loan to do improvements in their home. But I always wondered what would happen if the economy crashed or there was a recession.
You may have a mortgage and a home equity loan at the same time. The home equity loan is then your second mortgage. Usually the banks will allow you to borrow up to 85% of the equity in your home between your mortgage and the HELOC. A HELOC is a revolving form of credit with a variable interest rate. The rates are usually higher than a mortgage rate.
The new reality of the housing market is a recession which I believe is coming creates uncertainties for borrowers. Remember back in the Great Recession, banks froze previously approved lines of credit. You are seeing banks now limiting the credit lines on your credit cards and increasing interest rates. Can your lender do the same with your HELOC?
Your lender can legally freeze or reduce your HELOC if the value of your home declines, your income declines, or your credit score drops. Here is some good information from Citizen’s Bank about a freeze or reduction:
Many people take out a HELOC to consolidate credit card debt because the interest rate on the HELOC is usually lower than the interest rates on their credit cards. That is the advantage.
The disadvantages of taking out a HELOC is that it is a secured loan against your home. The lender has the right to take whatever you put down as collateral. With a HELOC, that is your home.
Nobody pays off their credit card bills and takes out a HELOC with the intention of ever getting into debt again. But too many people do not develop good financial habits and just continue using their credit cards. Then they end up with credit card debt and HELOC debt. If they continue along this path it may become more than they can handle.
My opinion on this is that there are other ways to pay back credit card debt than putting your home at risk. The one that comes to mind is to consolidate your debts onto a zero interest credit card then do everything possible to pay your debt off within the zero interest period. You can also work with a reputable counseling service to consolidate the debt and pay it of over time. But while you are doing this, cut up your cards. Keep one for emergencies. I mean a true emergency which is not a vacation, dinner out, going to the movies or Starbucks or any other frivolous thing that comes your way.
I know times are hard right now but getting further into debt is not the answer. If you can’t pay for food, use the food banks. That is what they are there for. I know this is a touchy subject. People will say that you should buy food first but if you are truly in a bad way using the food bank is okay. Spend your money to pay your mortgage and/or HELOC or rent so that you have a roof over your head. Use your car to go to work, to a doctor’s appointment, and the food bank. Then park it so that you can save on gasoline.
Continuing my opinion, taking out a HELOC loan against your home to pay off credit card debt is a very bad financial decision. I’ve been alive a very long time and over the years I have seen too many people buying their first home and then using it like a piggy bank. They take a mortgage and then a home equity loan. They pay them off and then continue that pattern their entire lives. There are seniors who still owe mortgages or home equity loans because they did this. When your income has been reduced in retirement that becomes so stressful! Eventually the dam breaks!
If you took out a HELOC to fix up your home and know that you can make the payments, that is not a problem. But think twice about taking out a HELOC to pay back credit cards. It is a vicious cycle that can ruin you financially.
With our economy teetering and inflation rampant, I would be very careful about making any financial move unless it puts you in a better position. Don’t be the one who ends up making all the wrong decisions and regrets it later.
You all know that I advocate you paying off your mortgages early and that goes for HELOCS too. We have had quite a few of my readers who have done this. They can tell you how freeing that is. It is so nice to own your own home and not have to worry about anything but repairs, maintenance, and taxes. Many more of you are on the way to being mortgage free. Congrats to you all!
In my opinion, the best thing you can do in this economy is work on paying off any mortgage/ and or HELOC that you have. Just make sure that if you are paying extra on them, that the extra amount goes directly to the principal and that you are not prepaying interest. If you don’t advise them, they will do what they want. What we did way back when we had a mortgage was to make the payment and then give them a second check advising them on the check that this is to be applied to our principal only.
Good luck to anyone who is thinking about paying these off early!