The Hidden Traps within HELOC’s and Equity Loans
“Home equity is a means of accumulating wealth, not a piggy bank”.Todd Emerson, Founder & CEO – Credit & Debt
I have been a homeowner for over two decades, and I have seen the worst and the best of the housing market. Without a doubt, the 2008 financial/housing crisis was the worst of the worst.
Reverse engineering the market crash
From Wall Street to Main Street, and throughout the banking industry, the federal government spent hundreds of billions of dollars trying to sidestep a financial catastrophe, and I had a front row seat.
At that time, I was spending a lot of time in Washington DC and worked with some of the smartest and most dedicated people trying to help consumers stay in their homes and helping the US Treasury disseminate billions of dollars to financial institutions on behalf of consumers who wanted to keep their home.
There are many reasons for what happened in 2008, and the years leading up to this point, but in the end, I truly believe it was greed – both by the banks and the consumers.
Housing prices were rising at such a rapid pace and creating so much perceived wealth, it felt like everyone who owned a home became the millionaire next door overnight.
There were only a few who made it out
Now, that may be true for a lot of people; the conservative ones that stayed the course either didn’t tap into home equity or became a real estate mogul/contractor overnight and attempted to buy and flip ever house they came in contact with.
And why wouldn’t most people do this?
Because living next door to them was the newly licensed mortgage representative (this was their side hustle) looking to give you an adjustable-rate mortgage and the courage to take on the world.
Since when do we take financial advice and guidance about something so serious and life altering, from our next-door neighbor, best friend or cousin, that is doing this as a second job? (No disrespect to the individuals that did it the right way).
So, is a home equity loan a good idea?
Let me be very clear about this next point:
Home equity is a means of accumulating wealth, not a piggy bank or slush fund. If not used properly, it can make it seem very easy for people to live beyond their means.
And this is the fundamental problem with homeownership and equity today. To understand this concept, we must first understand the difference between an asset and a liability.
How an equity loan works
I tend to lean towards Robert Kiyosaki’s thinking — the author of Rich Dad, Poor Dad — who says this on the matter: Your home is a liability and does not become an asset until it is sold.
The only portion that can be considered an asset is the equity (the difference between what you owe and what the home is worth), which can only be accessed through sale.
Even if you take out a HELOC (Home Equity Line of Credit) or a Home Equity Loan, you still owe on the money, which makes it not yours.
Now, of course, there are millions of people who know how to properly use these financial instruments, but there are also tens of millions who are not disciplined enough to manage their money on a daily basis, let alone have access to what feels like an unlimited supply of cash.
Financial literacy is the key to building wealth
I can remember when my wife and I bought our first home in our community in 2001. It was a very special time, and besides, this was our first home in a newly developed community. I remember being nervous about signing the loan documents because the cost of the house was more than my parents’ home that I grew up in. I wasn’t 100% sure I was doing the right thing.
Plus, if personal finance is not taught in the home, this big purchase can be over-whelming for anyone, which is why I am such an advocate for financial literacy.
As special as this memory was for me, the thing I remember most was sitting at stop lights with my wife and asking her, “How is it possible that every car beside us is the biggest luxury SUV or a brand-new Mercedes, and what are we doing wrong?”
To further confuse me, I deduced most of the drivers in those cars were stay at home moms, with some type of sticker that denoted their husband was a fireman or police officer.
I had a good job at the time, and my wife has always worked, even though she could probably stay home if she wanted to. But please don’t tell her I said that.
We watched our money very closely, didn’t live outside our means, and even took a weekly allowance. I am very proud to say, that after 20 years of marriage, we still take the same amount each week, the same that we did twenty years ago, and have never changed the amount.
A costly source of income
Remember those people I was telling you about at the stop lights? Well, it seems they could afford their lifestyles on a single income, because they had another income that I was not aware of at the time: home equity.
We knew more people who refinanced their home so many times, that eventually they owed more than their home was worth and they lost it to foreclosure or simply defaulted and walked away to try and start over. Now, I know very little about behavioral economics, but this is how I know that a large portion of consumers/humans are either inherently greedy or know very little about personal finance.
“What is infinite? The universe and the greed of men.”Leigh Bardugo, Shadow and Bone
Between 2006 and 2008, and at the height of the market crash, 1 in 6 homes in my community were in default. My community has 12,500 homes.
That is approximately 2083 homes or 17%. That’s a big number.
When my wife and I purchased the home we currently live in, back in 2009 (I would consider this to be the height of the crash), every home on this street, with the exception of the house we were purchasing, was in default.
Some of the homes were owned by the same person, and these houses were not cheap. But at that time, everyone had access to equity, and according to everyone’s neighbor that was the newly licensed mortgage representative, “the housing market is always going to increase.”
So, what is the moral of this story?
Know what you are getting yourself into, and certainly don’t bite off more than you can chew.
Don’t become a victim of home equity loans
There are many hidden traps within HELOC’s and Equity Loans. If not used properly and for the right reasons they can end up costing you more, or even worse, can cost you your home.
Here are few things to lookout for before tapping into your home equity:
- Rising interest rates affect monthly payments and total borrowing over the life of the loan or line of credit.
- Fluctuating monthly payments can cause financial instability or cause you to go deeper into debt.
- Interest only payments can come back to haunt you, simply because you want to make the smallest payment each month.
- If you are trying to consolidate debt, going this route will more than likely cost you more in the long run. Besides, there are smarter more effective ways of getting out of debt.
Know what you are getting yourself into and be disciplined enough to use the money in a financially responsible way.
You don’t need to keep up with your neighbors. Take the time to educate yourself on all matters financial.
“To Plan, or Not to Plan, That is the Question.”
There is an ancient Chinese proverb that says:
“The best time to plant a tree was 20 years ago. The second-best time is now.”
The same is true for most things in life, but for saving, it means everything. There are few economic principles as powerful as compound interest, and the earlier in life you start saving and investing, the faster your understanding becomes. There is also a wise saying that goes “Do as I say, not as I do”.
Unfortunately, this was the path I started on because debt was my biggest obstacle.
My first financial plan was flawed
Armed with a degree in economics, you would think I would have a solid understanding of investing, and I did. To make matters worse, I had series 7, 6, and 63 licenses because I was starting my dream career as a stockbroker. I know, I know, its’ either ironic or laughable, but it was true. I lived under the mantra to “fake it until you make it” because that was my way of excusing my financial behavior.
I wasn’t equipped to make good decisions around personal finance, credit, debt, and investing, regardless of my degree or licenses I possessed. You see, I thought I could outsmart father time, but I lacked the basic understanding of financial planning principles, and the common sense to apply them.
I am convinced that good money habits start at home, and without them, it puts you at a serious disadvantage. Sure, my parents were savers and lived within their means, but they lacked the understanding of how the stock market worked, compound interest, and the benefits of passing this along to their children.
Mom and dad’s financial plan wasn’t sound either
My parent’s strategy was to save everything, live within your means, and pay in cash. They had zero to little debt and used savings accounts and CD’s to protect their money. You might say, “what is wrong with that?” Well, let me tell you how that plays out.
I am also convinced that my parent’s financial strategy was handed down to them, and in their minds, it served them well. I would also argue that their strategy was flawed, and would have lasting effects for years to come, for both myself and my sister. They never shared much about their finances and as I got older, I was too proud or too embarrassed to ask for advice when needed.
I had a degree in economics, I should know everything — right?
This attitude leads to living outside your means, never saving for retirement, and getting so far into debt that you feel like you can’t breathe.
The two types of wealth
In my view, there is two types of wealth: 1) Asset rich and 2) liquid. My parents were asset rich, paid for everything in cash, no debt, and started saving for retirement later in life. This sounds pretty good, but they didn’t understand the potential tax implications of mortgage interest and how to use it to your advantage, they just complained about paying taxes. In fact, one of my dad’s favorite financial moments was having enough money in his checking account to pay for a new car with his debit card.
Listen closely — this only makes sense if you treat your money like employees and require them to always be working for you. Depleting your cash position to buy assets outside of this scenario doesn’t work or make good financial sense. You will never be truly liquid.
The advantages of financial planning for retirement
By starting early with saving and investing – and avoiding debt at all costs – you’ll likely become self-sufficient and have more control over your life. You don’t want to depend on Social Security, Medicare, Medicaid, or even relatives to take care of you in retirement. If you start saving early, the time value of money and compound interest will take care of you.
Both of these principles are beautiful things. It will help grow your money while you are sleeping (think of this as your side hustle when first starting out). All you have to do is invest small amounts of money over the long run and leave it alone. Sounds simple, because it is simple.
A long term financial plan begins with time
You can find several calculators online that can demonstrate these principles, but here is one scenario that puts it in perspective:
Take two people saving for retirement, one is age 22 and the other is 52. If they both start saving for retirement on the same day, and saving the same amount, $475.00 per month, and assuming only 8% interest, the results are staggering — at age 67, the 52-year-old has accumulated $167,148 dollars, and the 22-year-old has accumulated $2,379,328. Not too shabby, and more than likely the 22-year-old has other investment accounts and could call themselves a millionaire by age 45 or 50. If that type of thing is important to you, then remember that this is what being liquid looks like.
Remember: financial freedom is possible!
Anyone can possess assets or have the appearance of wealth, but to have the ability to purchase what you want, when you want, and without depleting your cash position or having the fear of getting further into debt, that’s financial freedom and being liquid.
And I am here to tell you, it’s possible. So do as I say, and not what I did!
Start saving early, avoid getting into debt at all costs, and never be too embarrassed to ask for help if needed. Like I always tell my daughters, there are two approaches to life: an easy way or a hard way. The easy way may be harder in the beginning, but it always pays greater dividends over time.
Money Doesn’t Grow on Trees
I have a love/hate relationship with one of the most popular parent quotes on personal finance.
If you are under the age of 18 you probably hate it, and if you are a parent like me, well, I am confident it is your “go-to” when your children ask for money. If you haven’t guessed it yet, let me tell you;
“Money doesn’t grow on trees.”
Now, with this basic principle out in the open, let’s assume for now, that it doesn’t. Another day, another article, I will argue the opposite.
Talking to kids about money is important but not always easy
My two daughters mean the world to me, and there isn’t anything I wouldn’t do for them. Of course, there are boundaries and rules, but I am still a sucker for any request, and I will move mountains to make it happen on their behalf.
We have a great relationship, and we speak openly about most matters. I started discussions around money with them, as far back as I can remember, and no topic was off-limits. We talked about credit, debt, savings, investment, and why all of these items were important, and what role they would play during their life.
As with any two people, they are very different in how they act, think, and their approach to life.
In my last post, we talked about my oldest and her lessons on hard money lending and interest working against you. I am happy to say at age 17, she is a saver by nature, an active investor, and understands most financial principles.
But my youngest — well, that’s a different story. As hard as she tries, and she is only 13, money still burns a hole in her pocket. Another “oldie but a goodie” financial saying from the past.
How to teach your child the value of money (maybe)
She talks a good game, but she is still under the belief that my money is her money, and well, that tree outback, it is evergreen and always will be. My focus today will be on her, and helping her understand the value of money, the cost of money, and the time value of money. And of course, that money doesn’t grow on trees.
This past Christmas all she wanted was an e-bike, which seemed manageable, and it was the obvious craze in our community due to Covid 19 restrictions. It seemed at times, there were more e-bikes on the road than cars. On the face, it seems to be a reasonable request, but that has to be measured against the other requests from her and then ensuring a proportional balance to my oldest requests. We like to keep things balanced in our home, which leads to less arguing about who got more, or who is the favorite in the family. Funny how kids think sometimes. And in case you were wondering, the cost of the bike was $999. Remember that, I’ll reference that number again.
Compared to other bikes on the road, this seemed beyond reasonable for my youngest, and to be honest, I had kind of a “proud papa” moment because she had chosen one of the least expensive models, which is NEVER her style.
Remember, she still firmly believes my money is her money. What I can afford, she should be able to buy. But I truly thought this was a break-through moment, and I happily purchased the bike she wanted, put it together Christmas eve, and had it waiting under the tree the following morning.
Problem solved, lesson learned; I’m the greatest Dad ever…right?
Then that little voice inside my head said, “Slow your roll big guy. Just wait, it’s coming.”
And it did.
It didn’t take long…
Less than three weeks on the road — and after all the discussions around safety — my youngest drives into a parked car on the opposite side of the road she was supposed to be on, at top speed (20 mph), and smashes the driver’s side tail-light and back panel.
Now, to her credit, her immediate thought was to inform the owner, and not her own health (she had a few scratches), and not the condition of her new bike. It had a few busted items as well.
Once she was through with her hysterical stage, wait for it, she then inquired about how fast I could get her bike up and running, and when I could pay for the car she hit, so that she could feel better about riding again.
Our conversation went like this:
Me: “How much money do you have?”
Me: “Not even Christmas money?”
Her: “No, I wanted to buy more hoodies and vans.”
Me: “Great, you haven’t learned anything.”
Does money grow on trees?
After much discussion around the cost of the bike, her safety, and the fact that money doesn’t grow on trees, I had to go speak to the owner of the car she hit, which happened to be a brand new 2021 BMW, that he had leased for his wife.
He was grateful that we owned up to it, and he would provide me with quotes to fix the damage. He was gracious in speaking with my daughter, and she of course said thank you, and “my dad will be happy to cover it.”
Yeah, you heard me, I would be “happy” to pay. As much as I wanted to talk about cash, credit, debt, and what I could do with that extra money, I waited until I had the final quote in my hands.
The final quote arrived: $1,500. My daughter’s response? “That’s good, I thought it would be more than that.”
I then walked her outside and asked her to tell me which tree she would like me to pick the $1,500 hundred from, and if she didn’t one, how would she like to pay for it.
My youngest currently receives $15 a week for allowance, and if her chores are completed. And if I am being honest, she should receive it at most, five times a year, but I am softy, and she gets paid each week.
Now at $15 a week, per year, it would take her two years to pay it off. So, I made an offer to lend her the fifteen hundred at 3%, which would be my minimal cost if I took the funds from a savings account, never-mind losing 25% in the market on that money in the current market.
I thought it was more than fair, and besides, she never found any money outside on any of the trees. She didn’t agree with any of my logic and said she would figure it out.
Fast forward a few weeks. Of-course I paid the gentlemen for the damage she caused, and I would never make her pay. It was an accident, and she was healthy. That’s all I cared about. Money can be replaced, but she cannot.
But she needed to learn the importance of not having money when you need it, not having to borrow and paying interest, going into debt, and that my money is not her money. I am confident she didn’t learn much, but at least she is thinking about it, and she now knows the new cost of her bike is $2,500, versus the original $999 price.
An expensive money-lesson for kids
But a lesson none-the-less. I will continue to teach my children about money because it’s important and foundational to growing up. It might take her a little longer, but she will always be worth it, and in the end, everything worked out — almost.
I would be remised if I didn’t tell you how the story ends. Two weeks after paying for the damage and repairing her bike (I managed to fix it, and the cost was a few hours of my time), I caught her riding her bike with 2 passengers and no helmet.
I told her to immediately ride home, park the bike and hand me the keys. She had violated the most important rule on the road, and she knew the penalty. I’m happy to say my wife is the proud new owner of an e-bike, and that my youngest is protected from doing any damage to herself because she was too cool to wear a helmet.
My only hope is she is plotting to earn more money and saving for a new e-bike to call her own.
Death by 1,000 Asks: Teaching Kids About Money Management
One of my father’s favorite sayings when I was growing up was, “Boy, you can twenty-dollar someone to death.”
Why did he say that? Because when I was growing up, that was typically the amount it took to fill up my car. And why did I need it? I had a job, received a regular allowance, but I was not a saver by any stretch of the imagination, and I always needed gas money.
Needs vs. wants
Although I thought I “needed” gas money, my father saw it as a want, because I couldn’t manage my money. The problem is, he gave me the money and it took me several decades to learn a fundamental principle of finance: The importance of saving money, living within or below your means, is paramount to your long-term financial viability.
One of my favorite stories that I enjoy telling, is taking my daughter to the mall when she was younger, maybe around age seven or eight. She was familiar with money, and by all accounts, a pretty good saver.
She would keep half of her birthday and Christmas money placed neatly in a small jewelry box on her dresser. The other half went to her savings account. But whenever Mom needed some time alone, my daughter would want to go shopping. And I was happy to oblige.
We would spend time looking through all the stores, multiple stops at the food court, and countless times back and forth to the restroom. There were a few stores in particular that little girls liked more than others (they will remain nameless, but let’s just say this is the place where you are able to get your ears pierced and buy more junk than any other store in the mall).
And you might even think that the lesson on the face is about “need” versus “want,” but you would be wrong. Although, that was a major point for me at the time.
An opportunity for a financial lesson
The problem was, my daughter would find that one thing that she wanted, and it was just that, a want, but she always conveniently left her money at home. Typically, I wouldn’t have a problem buying her what she wanted – she’s my daughter and I am her dad, that’s what we do. But her request took me back to my childhood and what my father said to me. More importantly, it reminded me of what he didn’t teach me.
So, my response was very simple and more effective than I would ever imagine. It went something like this, “Sweetheart, are you familiar with the words loan or interest?”
My daughter had no context of what I was talking about and probably didn’t care, she was too focused on the ask. So, I told her, “Of course I will give you the twenty dollars, but when we get home, you will owe me twenty-five dollars.”
That first time, and without hesitation, she took the twenty dollars and bought her item. We walked around a little while longer but never discussed the payment that was coming when we arrived at home.
When we did make it home, I gently reminded her of the payment, and she paid me. She didn’t question it then, but I could tell the wheels started to turn. My wife thought I was crazy and told me to stop teasing the girls. And of course, I didn’t listen.
This would become her first lesson regarding hard money loans, payday lending, and high interest rates. Whether my daughter realized it or not, I had planted a seed.
Teaching about the cost of borrowing
The next time we went shopping, we walked our usual route and ultimately ended back at the store I loathed the most. Within five minutes she asked for twenty dollars, and of course, I immediately obliged. But, I upped the ante to make my point and requested thirty dollars in return.
She looked at me in total disbelief and a little sadness, the way daughters can. I’m not going to lie, it hurt, but the lesson was far too important to me.
She thought about it for a few minutes, then put the items back on the shelf. She turned and looked at me and asked, “Daddy why would you charge me more? Did I do something wrong?”
Again, crushing me as only a daughter can. And I responded, “of course not, but you need to understand there is a cost to borrowing money.”
Hard money loans and payday lending might have a place in this world for some, but people need to understand how much they will ultimately pay for quick access to cash. Had they saved just 10% of what they had earned, chances are, they would never get caught in this trap because they saved sufficiently for future emergencies.
There are better options than these quick loans, like borrowing from family and friends, a credit union, or even using a credit card if needed. But above all else, understanding these basic concepts can make a huge difference in your life.
There’s always a new financial lesson to teach your kids
No matter what stage of life you’re in, take the time to learn the basics around money, saving, interest, credit cards, and how they can work for you or against you. If you are a parent, giving your children an allowance because they performed some simple chores around the house is not enough.
Take them to the bank and make them save half. When they are old enough, introduce them to more sophisticated topics like the stock market, compound interest, 401K’s, or even Roth IRA’s. These are life lessons that will never fail you or your children. So, if you take nothing else away from this article, take this:
Taking any opportunity to teach your children – or anyone, for that matter – about money will pay greater dividends than any other investment in the long run.
What is the true cost of borrowing money?
I grew up in a household where I was taught to serve others and always do the right thing. Get good grades to get into a good college. Find a great job so I could support a family.
All sounds good, but there is a flaw — I was never taught how to manage my money, the pitfalls of credit cards and debt, and how they could potentially ruin my life.
“I was cash rich but asset poor, and my life as a waiter created this mythical world in which I lived.”— Todd Emerson, CEO – Credit & Debt
I started living on borrowed money — and I regret it.
I moved to California in 1999, well-educated with a degree in economics. I was single, had eight credit cards in my possession, $23,000 dollars in debt (not including student loans), and $1,600 dollars in cash. I met my wife within four months, and my financial perspective changed forever.
I vowed never to be in that situation again, and I have kept my promise ever since.
But why did I get into debt?
Now that you have the back story, let’s talk about how I got here. I grew up in a competitive world, always involved in sports and an average childhood. I’m not sure why my competitiveness crossed over to personal relationships in my early childhood, but I never really felt good enough, and I was more concerned with what my friends had, and I didn’t.
And to be honest, I’m not 100% sure I didn’t have those things, but that is how I felt. I was more concerned about what others thought of me than I was at becoming the best version of me, and it followed me through college.
1. I was young and an “easy target”
The first day of college was a blur, but what was clear on that August day in 1987, was the opportunity to level the playing field.
There were no less than 15 credit card representees eager to give me an application, and a free t-shirt or large pizza coupon, all in an effort to bet on my successful future and my ability to make payments.
Or so I thought.
I was an easy target, and they could see it in my eyes across campus. I signed up for every card that I was eligible for, took my free t-shirt and pizza coupon, and headed off to class like someone who just won the lottery.
If I could change any single thing in my life or do it again differently, this would rank pretty high.
2. I wasn’t educated on how to use credit cards wisely
It didn’t take long for the cards to arrive, but I had no clue how the next few years and my lack of understanding around personal finance would wreak havoc on my life. I wish my parents would have taught me the fundamentals of credit and debt, and not just tell me to stay away from credit cards.
They can be good in the hands of the right people, at the right time, and with an understanding of the wise use of credit — but I wasn’t that person at the time. My experience was completely negative and my high was short lived.
Sure, I could try to impress my friends and pick up the tab, hit the upscale stores and buy clothes when I wanted, it was unlimited cash flow in mind!
3. I paid the true cost for borrowing money — compounding interest
And then the bills came, and they didn’t stop. But wait — you mean I can pay $25.00 minimum payment and continue my bad habits? Sign me up!
That’s what I did, for many years. And who cares? I was cash rich but asset poor, and my life as a waiter created this mythical world in which I lived. That’s a whole different story for another time, place and economic principle. Let’s stay on point.
“First and foremost, he with the most cards loses, he doesn’t win. “— Todd Emerson, CEO – Credit & Debt
Here’s the main lesson I learned about borrowing money:
First and foremost, he with the most cards loses, he doesn’t win.
Multiple cards only gave me greater exposure and risk to interest charged on multiple cards. The temptation or urge to use them at will, makes it way too easy to spend. With credit cards so readily available, all my “wants” were within reach – they were unlimited. I never thought about late fees because I had minimum payments.
To put this in perspective — to pay off that $23,000, it would have taken me over 30 years and $63,995.11, using an interest rate of 18.9%, and assuming a 2.0% minimum payment. And ladies and gentlemen, that is the negative impact of compounding interest. This is an easy calculation, and most personal finance reputable sites have these, so I used the one from bankrate.com.
Don’t become a victim of debt.
Again, in the right hands, credit cards have plenty of upside and benefits. From building credit for the first time or earning points based upon which card you have. It’s typically never the card that gets you into trouble, but more the person’s lack of understanding the wise use of credit.
In terms of our personal financial planning, we need to be absolute in our understanding of personal finance at all times despite the ever-changing economic landscape. Learn as much as you can, benefit from the knowledge and begin to accumulate wealth.
The economy will always change, and maybe even where you are in life, but that doesn’t mean you will become a victim of debt. Always stay in front and continue to learn everything you can. In the end, you will win, and win big.