Y’all have seen the ads: some smiling beautiful person is trying to tell the world how much easier their life is since they “paid off” their credit card bills by using their HELoC (Home Equity Line of Credit). It might have been on TV, in the newspaper, on the radio, or even online. It’s touted as the “smart” thing to do. There is so much wrong with this idea, I am not even sure where to begin!
First, let’s tackle the erroneous notion that you can “pay off” debt by borrowing (more debt). Yes, a HELoC is borrowing…it’s borrowing against the equity of your HOME. Dave Ramsey has a cute but very true saying: “You can’t borrow your way out of debt.” He is 100% right on that point.
Now let’s look at the (lack of) wisdom in this strategy: The notion that taking unsecured credit card debt and moving it to a secured debt situation is “smart”. Credit card companies will scream, holler, and cry blue murder if you don’t pay them … trust me I have had personal experience with this … but the worst they can do is ding up your credit report (and score) then discharge the debt and sell it to a collection agency who usually has as bad or worse phone tactics.
A HELoC puts your home up as collateral. At best, if you can’t pay on a HELoC they put a lien on your home. I have heard in some states, a HELoC in default can trigger foreclosure proceedings. So what is smart about that?
“But the interest rate is so much better…!” Yeah, there is a reason: secured debt is always a lower interest rate because if you default they can always come seize the collateral to recoup their losses. Therefore the loan is less of a risk for the lender when they can take your car or house and sell it at auction.
“But it’s one easy payment…!” First of all, I have never actually had an “easy” payment. All payments have some degree of pain associated with them, even my mortgage (which apparently means “death contract” according to David at My Two Dollars). Second of all, it might be “easy” now, but what happens when there’s a layoff, or medical emergency, and you suddenly aren’t working or working less than before? Instead of a bunch of little payments you can prioritize, you have one big payment now and it’s an all-or-nothing situation.
Even worse, I have seen, heard, and read many financial experts say people should open up a HELoC as an emergency fund rather than save up cash! According to statistics (and yes I know statistics are one of the three kinds of lies), the number one reason for bankruptcy today is a sudden medical emergency and the bills and debt and time out of work associated with it. If this is your emergency, how can it possibly be smart to jeopardize your home as well as all your other debt obligations? Or if your emergency is a layoff, how can anyone call it smart to take on more debt - especially the secured kind?
The absolutely most irresponsible marketing of a HELoC is for “fun” stuff: vacations. This is the one I have never been able to understand, even in the depths of my financial ignorance. Why in the world would anyone offer up their home as collateral for a vacation? Someone please explain the rationale behind this notion! I just don’t get it at all … what is the justification thought-process behind this? I know it’s being continuously marketed for so long because the marketing works and people actually do this - I just don’t understand why.
I know I am biased; I am debt-adverse. The only two things I can possibly think of to use a HELoC for are major home repairs and major home improvement before a sale. Definitely not for transferring credit card debt … definitely not for emergencies … and absolutely not for fun stuff! In fact, I am wondering if the HELoc-mania as a financial panacea is part of the reason people are finding themselves upside-down in their mortgages, and if it is part of the reason for the foreclosure rate now hitting records?
Just one final thought: your house is not supposed to be an ATM machine; it should be your home and castle! Maybe we should go back to that idea.
Note: This is part of a group project about mortgages, homes, and foreclosures involving several PF bloggers, and I will provide a wrap-up on Thursday evening or Friday morning of everyone particpating.