Home Equity Hazards

by Nancy Osborne, COO of ERATE

While using your home equity can be a wise, tax-advantaged strategy when prudently applied, it can also be down right dangerous when misapplied. Home owners have been taking out home equity lines in record numbers to fund all types of consumer purchases. Almost 25% of all homeowners in the U.S. have a home equity line of credit (or HELOC) secured against their primary residence. In the past ten years it is estimated that U.S. household debt overall has increased by over 145% and at the same time credit card debt has risen almost 70%. The conclusion is that home owners are using their home equity, or borrowing against their homes, to either pay down or pay off their credit card balances.

Lax underwriting restrictions may have permitted many homeowners to take out lines of credit up to 75%-90% of the value of their home. These loans are frequently available at attractive interest rates and at little or no cost. On the east and west coasts, home equity lines of up to $500,000 are not uncommon. The concern with this practice is that by using the equity in your home as collateral for the loan, you are putting your very place of residence in jeopardy. If you rack up too much credit card debt and find yourself in over your head, the worse thing that can happen is that you ruin your credit and perhaps reach a point where you consider filing bankruptcy but you don’t have to lose your home in the process.

If you exercise prudent money management skills, your home equity could be an excellent resource at your disposal for making long term investments requiring a sensible tax advantaged strategy to achieve (as you may typically deduct the interest on a HELOC, depending upon when the home was purchased, up to your acquisition indebtedness on the home plus $100,000). However a home equity line shouldn’t be used as a "cash register" for making short-term consumer goods types of purchases and should not be seen as a way to further enhance your spending ability. Sensible reasons to tap into ones home equity include: home improvements, investing in a real asset, financing higher education, converting existing unsecured higher interest rate debt to secured lower interest rate debt, to purchase a new vehicle (of course you should always try to drive a car for 8 to 10 years before buying a new one) or for emergency funds in case of short term job loss or for covering unplanned medical bills.

Think carefully before writing a check against your home equity line and consider whether the risk of potentially losing your home justifies the reward obtained by using it. Ever rising home values are no longer a given as the median home price continues to fall from its peak. Using your home as a cash register for consumer purchases never made sense and it makes even less sense now than ever before.

Always consult with your tax or financial advisor regarding your own individual circumstances before proceeding with any plan which may have a dramatic impact on your personal finances.

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  Nancy Osborne has had experience in the mortgage business for over 20 years and is a founder of both ERATE, where she is currently the COO and Progressive Capital Funding, where she served as President. She has held real estate licenses in several states and has received both the national Certified Mortgage Consultant and Certified Residential Mortgage Specialist designations. Ms. Osborne is also a primary contributing writer and content developer for ERATE.

"I am addicted to Bloomberg TV" says Nancy.