The economy is at a high point in the economic cycle. People are feeling great. When this feeling pervades the general populace, the proclivity to spend rises. That means that many are subject to spending more.
Sales people love this part of the cycle. The entire sales process is easier since the general tilt of everyone is to be more liberal with their spending habits. Gone are the days of hunkering down to meet expenses.
Many items are pitched as “no cost”, “low cost” or “discounted”. Home equity loans are just one example of the many items being pitched. The “hook” may be that the loan is “low cost” or “no cost”. Well, like they always say, you don’t get something for nothing. If it is no cost, you can be assured that the “costs” are still there, just hidden. How? Well, the costs are wrapped up in the total amount borrowed or the interest rate is higher to compensate for their costs. Do you really think they are just going to give you a great loan, like my mom would say, out of the goodness of their heart?!
If you have equity in your home and you really need those funds, not just want those funds, a home equity loan might be a good decision. Suppose you have a medical expense that you are unable to make. Although usually with a medical payment you have other options, such as small payments over an extended period of time. Or, you could use your inability to pay it back to leverage the provider to negotiate down the total amount. They would rather have something versus nothing.
Let’s first look at how long it takes to build equity. If you have a 30 year fixed mortgage, for the first few years only pennies are applied to your principal. The amount applied to your principal grows over time, but very slowly. This means if you have any equity in your home, it has taken a long, long time to build. By taking a home equity loan, you can spend that hard earned money very quickly and, then, be stuck with another debt. If anything changes in your income situation, that additional debt could cause real pain to you financially.
To understand building equity, you should get an amortization table of your mortgage. Observe how long it takes for equity to build up over time. The equity is the difference between what you could sell the house at currently and the principal you owe on your original mortgage. Look closely at how slowly…. the principal value of the loan decreases. Many don’t understand this key item, but they really need to understand it!
Like the housing crises, many thought they could sell their homes at higher and higher values. Therefore, they got wrapped up in projecting an increasing value of their home. The expected increasing value leads them to believe the equity will keep going up. This is exactly like the stock market. People pay higher and higher prices when they assume the stock will rise and rise and rise.
Let’s look at interest rates another way. The person/organization loaning the money is willing to give up current spending to achieve more spending power later. After all, they will grow their money by collecting interest. The person/organization borrowing money is willing to give up their future spending to get more now. Eventually, the borrower is going to have to pay more. There is no “free lunch”!
The amount of money you will have to pay “later” on a home equity loan will grow. So, be prepared for that eventuality.
Ultimately, you have to ask yourself - Do you have to have this money now or do you just “want” to have it now? You have to make this determination, but, be assured, you will be paying for it in the future. Since you clearly don’t have the money now, are you going to have it in the future? Many will chose, just like home prices in the great recession, to project higher income levels to meet those higher future expenses. This is exactly what so many people did during the housing crises!
