Home equity lines of credit have been an attractive loan in the past few years due to the obscene housing boom that left homeowners sitting on gobs of equity in their homes. So, instead of sitting on their profits, homeowners borrowed against a “theoretical” amount of money. Why do I say that this is a theoretical amount of money? Well, if you owe $80,000 on your home, and you can sell it for $100,000 on the market today, then you have $20,000 in equity. Banks are allowing people to borrow $20,000 at a decent interest rate, then if you sell the house, you can break even after paying back both loans.
But what happens if the market goes flat and you can only sell the house for $95,000 now. You are now upside down on your house! This means that even after you sell your house, you’ll still owe more on it. I know that this is a speculative and broadly general example, but do you get what I am trying to say? There may be a situation where you had $100,000 in equity, so you borrowed $20,000 against the equity to consolidate your credit card/car loan debt. I do not particularly have a problem with that, but we must keep reminding ourselves that consolidating the debt does not cure the problem of spending more than we make. It just restructures your debt. However, it is a good move if you are dedicated to paying off that debt and you are seeking some relief from high interest rates that most credit cards possess. Home equity lines of credit usually have rates between 6 – 8% which makes them attractive to those wanting to consolidate debt, make home improvements, or go on vacation.
My point is that borrowing on your home’s equity is more risky than people think. You are borrowing on the promise that you will be able to sell the house for a given amount at all times. We know that the market fluctuates, and that is why home equity lines are riskier than they look. If you made nice home improvements to your home, then you probably boosted the value of the home. This would be a decent use of using a home equity line.
Fact to Remember: Many equity lines are interest-only loans, so paying the minimum amount each month on them will not pay down the principle amount at all.