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Debt Diaries

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:

  1. Rising interest rates affect monthly payments and total borrowing over the life of the loan or line of credit.
  2. Fluctuating monthly payments can cause financial instability or cause you to go deeper into debt.
  3. Interest only payments can come back to haunt you, simply because you want to make the smallest payment each month.
  4. 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.

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