Home Equity Roulette

Money magazine’s July issue has an article on the 50 smartest things you can do with your money. Number One? “Tap your home equity.” This is my nomination for the Worst Advice of the Year. But since Alan Greenspan has repeatedly applauded Americans for tapping their home equity, it has become heresy to suggest anything else.

Let’s start with the basics: The only way to “tap” your home equity is to sell the house and move to something cheaper. The cash you have when you sell is equity built up in your home, and you can invest it somewhere else. But borrowing against your home is just that: borrowing. You have to pay it back. Your home equity isn’t free money that is just lying around, waiting for you to “tap” it. It isn’t cash in a savings account, or money in your sock drawer. The only thing that makes a home equity loan any different from borrowing money from MasterCard or your cousin Judy is if you can’t make all your payments, the lender can take away your home.

Money magazine has all sorts of ideas about how to spend the money — pay down credit cards or use it in an emergency. But they have it wrong. If you are already in financial trouble, you cannot borrow your way out of debt.

While we are talking about the housing bubble, we need to talk more about home equity loans. They are one of the most dangerous forms of debt in existence. Every time someone borrows against their home, they are putting it on the roulette wheel, betting that they will be able to come up with every single payment.

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Neither Mr. Greenspan nor those cheerful advertisements with the smiling couples mention that people are losing their homes. They don’t show those couples on the day the sheriff comes to serve them with a notice of foreclosure. Right now, one in every eleven debt-consolidation loans is in foreclosure. That’s one in every eleven families who believed they were being clever when they “tapped into their home equity.” No one would try to save a little money by taking a medicine that had a one in eleven chance of giving them a heart attack. Debt consolidation loans should be treated the same way.

The advertisements keep blaring that a home equity loan will save money. But how much do you really save? Not as much as you might think.

Taking a home equity loan to consolidate debts is a lose-lose proposition. If you can get your debt paid off in a year or two anyway, the money you save on interest is pretty small, often less than the fees you paid just to set up the loan. And if you can’t get your debt paid off within a couple of years, you’ll keep paying interest on this loan, year after year after year. In fact, many home equity loans last fifteen years. Anyone who can’t pay off a credit card balance in fifteen years has BIG financial problems. And anyone with BIG financial problems should not be putting their home on the line!

There is one more catch. Anyone who is already in financial trouble will probably be steered into a super-high-cost second mortgage. Like the credit card companies that offer teaser rates to get people in the door, the mortgage companies offer good quotes in the ads — and much worse quotes in reality, especially for those with a less-than-perfect credit history. The fact that good, sober people like those who write for Money magazine would continue to urge people to borrow against their homes is one more sign that the housing market is in real trouble. Ordinary folks, people who don’t see themselves as big risk-takers, continue to leverage up their homes following such mainstream advice. When the housing market begins to reverse and they don’t have the option of selling the house to pay off the built up mortgage debts, then the housing crash will get a lot louder.

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