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Here in California, the ads are ever-present. “You’ve worked hard to build up equity in your homes. Now let your home work for you.” The ads may feature couples talking about spas, European vacations, boats, or whatever. The banks make borrowing against your equity seem like a painless way to enjoy the good life.

These loans are extremely painless and risk free–to the banker. After all the bank can always foreclose or place a lien if you do not pay your loan. So much for good credit. They can be extremely risky to borrowers.

Home equity loans can take various forms. One is a refinance of the original mortgage that is structured in such a way that you get some cash out which you pay back in the new mortgage. Another form is a separate loan against the equity in your home. You can also get a line of credit which means that you are not borrowing now, but you are able to later on when you find something you need (want?) money for. Some banks even offer credit cards secured by the equity in your home. Can you imagine what a shopaholic can do with that type of credit card?

Bankers know that things are slow. Until a year ago, many of us had a variety of ways to get extra money if we wanted it or needed it. Those of us with a little knowledge of stocks could find an under priced stock, buy some shares, and wait a few months for it to go up. Most of the time that worked during the bull market. High tech professionals could find a little consulting job on the side and use the money for a new car or European vacation.

Those opportunities are gone now for many of us, but our appetite for the good life is not gone. Bankers and their ad agents know this. With not as many people coming to the bank for long-term loans, bankers would much rather put on an ad blitz for home equity loans than lower interest rates to entice people to borrow.

Home equity loans can be useful, but they can be dangerous. You need to decide if the loan is right for you. Here are some questions to consider.

How sure am I that I will be able to pay off the loan? Let’s take two opposite scenarios. A formerly paid high-tech worker gets laid off. This has never happened to him before because he’s used to a great salary and not having to budget. He figures that he’ll get another job soon because he has great skills. He figures that while he is between jobs is a great time to travel. The economy takes longer to recover than he expected and he starts getting those nasty notices.

In scenario two, a couple finished paying off their mortgage three years ago. They had incurred a large number of expenses the past several years putting their children through college. They both have done well in their work. Their house, however, is not doing as well as their careers or their children. They need a new roof and paint inside and out. Most of their assets are in retirement accounts and they don’t want to be cash poor. They research the various options and find that a $35,000 home equity loan can help them have a house that they will enjoy and that will sell for more when the time comes.

Why am I considering borrowing against my home? People consider borrowing for many reasons. Sometimes it is because they are out of control as a result of poor financial habits. Sometimes it is because of an unforeseen, unfortunate event. Sometimes it is to make long-lasting improvements in my life or surroundings.

NEVER borrow against your home to make up for poor planning unless you are 100% sure you have solved your problem and then only after at least a year of making substantial progress at eliminating your debt. If you are into heavy credit card debt and want to use home equity to pay off that debt because it is less expensive, you may be looking for trouble. The same bad habits that got you into the credit card debt could cause you to default on your home equity loan, with much greater consequences.

Can I afford the payment now? Many people who wrongly use home equity loans are optimistic about the future. Maybe business is down in my company now, but that won’t last forever. I’ll just use some of my savings to make up for the shortfall for a few months (or worse yet, borrow against a credit card), but that will be only a short term phenomenon because, after all, this downturn can’t last forever.

Will the benefits of the what I do with the money last longer than the time I have to pay? Many of the ads suggest using a home equity loan for a boat (which also generates a number of expenses, such as docking fees or a trailer to tow it). If you take out a 20 year loan, will you still be enjoying the boat after you make the last payment?

One rule to staying out of the permabroke mode is to only use money to finance undertakings that will still be of benefit to you after you make the last payment.

Using a home equity loan to finance travel when you are between jobs certainly won’t fall within those parameters.

Home equity loans have helped many homeowners improve their lots in lives. Some have started businesses as a result of those loans while others have improved their homes and helped their children through college.

Too often, however, home equity loans of all kinds have taken over-extended borrowers to a new level of financial enslavement and have actually cost some borrowers their homes.

The tone of the current ads for home equity loans is very disturbing to me. They seem to be luring people to come in and finance wants and whims rather than needs and plans. They seem to appeal to the appetite we have gained during the last boom for more and more luxuries instead of encouraging us to take stock of ways to really preserve what we have and improve our financial lives. Some say this appetite for debt and goodies is stalling our recovery by keeping interest rates up. That explanation makes sense to me.

Copyright 2001 by Larry Wiener

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