Ask The Money Coach

Posts Tagged ‘home equity line of credit’

Q: I Had to Take out a Very Large Loan to Pay for One Year of My Son’s College Education. I Anticipate it Taking a Minimum of 5 Years to Repay. I am Also Repaying a HELOC loan. What is the Best Way to Handle This Debt? Should I Try to Pay Them Off as Quickly as Possible Reducing the Money I Would Put Aside for Savings, or Do I Pay What I Can and Make Saving a Priority? I Have a Bit Put Aside for Emergencies, but Nothing Substantial.

A: This is a classic case of “which should I do first – pay debt or save more”? The answer isn’t really a matter of either/or. It’s a question of how to do both simultaneously because that’s the best approach. You need savings to avoid going into debt. After all if you don’t have a cash cushion, the slightest emergency – like a flat tire or a leaky roof – will send you heading for your credit cards. Also, you should pay off debt as soon as possible because you don’t want to pay unnecessary interest charges and be prevented from saving money for other future goals. The good news for your situation is that both of the loans you’ve taken on – school debt for your son, and a home equity line of credit – carry relative modest interest rates. You didn’t say when you got your HELOC, but I assume it’s in the single digits (i.e. less than 10%, and probably significantly less if you got the loan in the past couple years). Ditto for that student loan. So divvy up the available cash you have and work at meeting both objectives: knocking down that student loan balance and your HELOC and also adding consistently, month after month, to your savings nest egg. If I had to prioritize, I would say slash that HELOC debt first and put more emphasis on that than the student loan debt. If it’s a federal loan, the student loan debt may be subsidized (meaning the government is paying the interest on the loan while your son is in school). Lastly, because the healthcare reform bill recently signed into law by President Obama includes student loan reform as well, you can expect college loan costs to come down significantly. For instance, starting in 2014, student loan repayments will be capped at 10% of a borrower’s income. That means even if you can’t pay off that loan in five years, your son can start working on it — and it’ll be relatively affordable for him to do so.

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Q: I Have $33,000 Worth of Unsecured Credit Card Debt. I’m Not Late on Any Payments, But I Am Living Paycheck to Paycheck. What’s the Best Way to Clear My Debt? Should I Refinance My House or Consider a Debt Consolidation Company.

A: I don’t think going to a debt consolidation company is the best strategy. And using a home equity line or refinancing your home may not be a smart move either, depending on why you got into debt and what your current situation presently looks like. When people ask me if they should use home equity to pay off credit card debt, here is what I tell them.

Using a Home Equity Loan

Getting a home equity loan or an equity line of credit can be a smart strategy for a few reasons. The interest rate on home equity loans (currently in the 6% range) is far less than what you’re probably paying on your credit cards (likely in the 15%-plus range). Additionally, the interest on home equity loans is tax deductible up to $100,000; the interest levied on your credit cards is not. Finally, from a credit-scoring standpoint, mortgage debt is treated more favorably than credit card debt, so converting that consumer debt is likely to positively impact your FICO score, by helping you reduce your credit card utilization rates.

A Strong Caution To Those Using Home Equity Loans to Pay Off Credit Card Debt

If you decide to consider this strategy, I have to issue a very serious word of caution: Don’t pay off those credit card bills, and put your home at risk with an equity loan if you’re just going to go back out and run up your charge cards again. The decision to take out a home equity loan is one that should not be made lightly. I believe that you should only use your home equity to pay off debt under two circumstances:

1)   You got into credit card debt because of what I call “The Dreaded D’s: (downsizing, divorce, death (i.e. a main winner in the family died), disability, disease, or some other disaster, like a business failure or lawsuit); and

2) The situation that threw you into debt has now been rectified. (For instance, you were downsized, but now you have a job, or you faced a disease or a disability, but now you’ve bounced back from your medical problems).

If you got into debt for other reasons of your own doing, such as over­spending, and if you haven’t learned how to get those impulses under control, I urge you to refrain from tapping the equity in your home to pay off credit card debt. I’ve heard heart-breaking stories of people who paid off their credit card debts by converting those obligations into mortgage debt – only to keep spending, not change their financial habits, and ultimately wind up losing their homes in foreclosure. I don’t want this to happen to you.

Read this advice I also gave to another subscriber about figuring out the heart of why you got into debt:

Lastly, here are some tips that anyone can use to raise cash and use the money to eliminate credit card debt:

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As of early 2010, I don’t know of a single mortgage lender who will approve a home equity loan on investment or rental property. They may exist, of course. But I’m simply not aware of any. Before the market downturn, banks would readily extend loans and lines of credit on rental real estate. Lenders typically stipulated that those properties could have no more than an 80% loan-to-value ratio. In the current market and amid the credit crunch, however, it’s very difficult (if not impossible) to find such a lender for three reasons:

• declining property values in many parts of the United States

According to the Case/Schiller housing index, home prices have fallen 30% since their peak in April 2006. And in many regions of the country, the declines continue.

• increasing foreclosures throughout America

There were more than 9 million foreclosure filings in the U.S. between 2007 and 2009. Moreover, experts at RealtyTrac predict we’ll see another 3 million foreclosure filings in 2010.

• more rental properties falling into default

It’s not just mom and pop rental property owners who are getting into trouble as landlords. In New York, the owners of the biggest apartment complexes in Manhattan even recently defaulted on their loan. Those apartment complexes, known as Stuyvesant Town and Peter Cooper Village, were bought in 2006 by real estate investors/property managers Tishman Speyer and BlackRock for a record $5.4 billion. Less than four years later, the property is now valued at less than $2 billion. The rental income never covered the mortgage/monthly debt service. But the investors had bet that New York’s normally solid rental market would help them attract tenants willing to pay higher rents, as the owners intended to convert the units from rent-regulated apartments into pricier apartments. Unfortunately, they bet wrong. Plans to convert apartments were thwarted. Plus, average rents are down in New York – just like property values.

Easier to Get an Equity Loan On Your Primary Residence

Lenders know that in a tough economy and a rough housing market, most owners of investment property will walk away from those properties, or go late with their payments, before those owners will sacrifice their own homes. Thus, if you need a home equity loan, you’ll get better interest rates, more available financing, and find more willingness on the part of lenders to get a deal done by taking a home equity loan on your primary residence – as opposed to the rental property you own.

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