The Home Equity Loan Zone

Home equity loan (HEL) ads are all over the place. It seems everyone is touting them as “the perfect way to consolidate debt.” And many people are responding. Between 1997 and 2004, according to Federal Reserve statistics, home equity loans and home equity lines of credit jumped from $416.2 billion to $826 billion. Actually, home equity loan debt is now far greater than credit card debt. Apparently, the ads work, but do home equity loans work?

Of course, you can switch high interest credit card debt for far lower home equity rates and even, possibly, get the chance to deduct on your state and federal incomes tax some of the interest you pay. But aggressive lenders fail to warn homeowners of the serious risks involved with home equity loans.

The most serious questions you need to ask yourself before getting into a home equity loan is “Will I suddenly now be able to control my spending and manage my money effectively? Or am I just going to max out my credit cards once again after I pay them off?”

Well, no matter how good your intentions are, the chances are you won’t clean up your money act. Very few people do. In a recent survey done by Brittain Associates, an Atlanta research firm, nearly two thirds of homeowners who consolidated their debt with home equity loans just ran up their credit cards once again in two years.

And many of these home equity loans were made to people already under financial stress because of low incomes and/or bad credit. Ten years ago, in a much more conservative mortgage market, most of these “subprime” borrowers would not have been considered creditworthy by lenders. They wouldn’t have qualified for a loan, even if they did put up their home as collateral.

But, in todays much more competitive and aggressive mortgage industry, it seems like anyone with some home equity can borrow against it, no matter what their income or credit status is. Depending on who you are, this liberality can be either good or bad.

It can be good, if you have the discipline to manage your spending habits. However, if you don’t have the discipline, you could end up losing the roof over your head. And, if you don’t believe the risk of foreclosure is serious, consider this. Foreclosures are on the upswing from coast to coast. In some states, like California, they’ve actually doubled in the past year.

And debt consolidation home equity loans to less than prime borrowers is a major cause of this increase in foreclosures. Subprime mortgage loans are very risky. At any one time, about 16% are delinquent and over 4% are in actual foreclosure. These default numbers are predicted to go up even higher in the near future.

Why? Because, in order to keep their payments down, many subprime borrowers chose to go with low introductory adjustable rate mortgages. As these ARMs revert to higher fixed rates over the next couple of years, some of these borrowers are going to see their monthly payments increase by as much four or five hundred dollars, which is more than they can probably handle.

If you’re thinking about getting a home equity loan to consolidate debt, you better be smart and be careful. They only really make sense if you’re absolutely confident you’re not going to just run up more debt all over again. And most conservative financial advisors don’t recommend HELs for consolidating debt. Instead, they believe home equity loans should be used only for such things as capital home improvements, emergency medical bills and educational expenses.

There are lots of other safer ways to pay off your credit card debt, so think twice before taking a home equity loan. That is, if you want to keep the roof over your head.