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Tapping Home Equity to Get Back in Black OK, But Borrowers Must Cut Spending Too

Beth Orenstein
LoanBiz Columnist

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With prices for food, health care and other essentials rising and the holidays around the corner, many consumers are finding themselves in the red. A home equity loan or a home equity line of credit (HELOC) can help spenders consolidate their debt and pay it off.  While lenders have tightened their qualifying standards, borrowers with good credit scores, adequate income, and sufficient home value can obtain home equity loans and HELOCS. 

Home Loans the Same in Any Economic Climate

The issue isn't as much whether borrowers can get a home equity loan or HELOC but what they do with it once they have it. Alan Klayman of Klayman Financial says the rules of wise borrowing don't change with the economic climate. "Borrowers should look for the lowest cost of capital, whether that is a zero percent balance transfer on a credit card, a personal loan or an auto loan, or a home equity loan or perhaps even a home equity line of credit." Once the borrowers have weighed their options and chosen the home loan, he says, they must stick to a schedule to pay it back. The worst thing borrowers can do is secure a home equity loan or HELOC and continue to increase their debt load.

Home Equity Loan, HELOCs Lower Borrowers' Monthly Payments

A home equity loan is granted for a fixed amount and is typically used for major expense such as a large debt consolidation, home addition, or medical expenses. A home equity loan is likely to carry a fixed rate of interest for a fixed period of time, and the borrower pays interest on the entire amount from day one--which is why it is better for those who need a large lump sum.

Typically, HELOCs are a good choice for those who are paying off smaller amounts of debt or debt incurred at intervals--like annual college tuition or a home renovation that will be done in stages over time. They come with no-or-low fees and interest rates are variable, but the borrower only pays interest on the amounts used. And a HELOC can be tapped and repaid over and over without incurring additional loan fees, which can make it the more economical option.

In addition to carrying lower interest rates than credit card and other consumer debt, home equity loans and HELOCS also come with interest payments that are often tax deductible. By consolidating debt with a home equity loan or HELOC, the borrower's total monthly payments should be lower and the interest expense should be less. That's the point of taking out the home equity loan in the first place.

Borrowers Who Use Home Equity to Consolidate Debt Have to Know When to Stop Joseph Blake, a chartered financial analyst in Bethlehem, Pennsylvania, agrees: "There's nothing wrong with a home equity loan or a home equity line of credit to refinance someone's debt in a more cost-effective way even in a down economy. The problem," he adds, "is that a lot of people who obtain a home equity loan or HELOC go back and spend again and are in the same financial position they were before they got the loan and may be even worse off because now they have the home loan and additional debt."

If borrowers can obtain a home equity loan or HELOC in this environment, Blake says, they must control their spending. "If you run up the credit cards again, you have missed the point," he says. "It's like going on a crash diet, losing weight, and then putting on that weight over again. What's the point?"   

Sources:
  • Blake, Joseph, Interview by Beth W. Orenstein, 17 November 2008
  • Klayman, Alan, Interview by Beth W. Orenstein, 17 November 2008
  • Mortgage Bankers Association

About the Author
Beth W. Orenstein, of Northampton, Pennsylvania, is a freelance real estate writer. A graduate of Tufts University, she majored in English.

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