Saturday, May 26, 2007

Dangers of Home Equity Loans

In a recent article, Dave Ramsey talks about the dangers of home equity loans. I found this to be a fantastic read, and it's rare that I find someone who doesn't believe in home equity loans.

As for myself, I don't believe in them either, because I do not feel that risking your most valuable asset, your most important one at that, is worth the benefit of a slightly lower interest rate. Read Ramsey's full article, but the meat of it is that he believes that home equity loans lull people into a false sense that they've paid off their debt, when really they've just moved it somewhere else.

I often hear this humorous phrase, 'I paid off my credit card debt with a home equity loan.' That's humorous because you didn't pay off anything, you just moved it. It just has a new name.

And although he doesn't say it outright, the amortized interest on a 30 year loan for your Disney vacation and steak dinner is going to cost you far more than a higher simple compound interest credit card.

The problem, he says, is our behavior regarding debt. Once our debt vanishes into our mortgage and our of our mind, people continue to accumulate debt.

The figures that we're seeing are that about 80 percent of the people that move their credit card debt onto a home equity loan don't change their habits and continue to go into debt further.

Worse, it seems Ramsey feels from his experience that people do not fully understand the terms of their home equity loans.

They don't know if they've got a variable rate; they don't know if they have to requalify credit-wise every one or two years.

Perhaps they assume the terms are the same as their original mortgage? Of course, this isn't true. A home equity loan is a separate loan that simply uses the value of your house as collateral.

when they start tapping that because everyone at the bank is telling them what a great idea it is, when they turn their biggest asset into their greatest liability

All math and consumer debt behavior aside, this is the single most important reason why I think home equity loans are evil. They put at risk the most important 'necessity' you have. Losing a home can be the biggest financial disaster you can face.

Home improvements? Vacations? Repairs? This country has fallen in love with debt and easy credit. More debt is not the answer.

You don't need to go on vacation unless you can pay for it. If you have a home repair, in almost every case, that home repair is not an emergency situation. We put a nice patio with a screened-in porch on the back of our home a couple of years ago. We just saved up and paid for it, same with the vacation...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.

I have not read much from Dave, but I'll be keeping an eye out for his articles.

People think I'm a freak because I don't believe in these loans and stuff

I for one find it refreshing that someone is speaking out about these loans.

1 comment:

J at IHB and HFF said...

Hello. I agree about it being refreshing. My whole blog tries to address dangerous "conventional wisdom" and my "Biggest Net Worth Mistakes" article even warned that borrowing against assets (e.g. a home-equity loan) can be a sucker's game.

I added your blog to my list.