Q&A: Using your home’s equity to pay off credit card debt is a dumb move

Dear Liz: My ex-husband is a self-employed carpenter who just turned 64. He’s gotten a bit over his head with his credit cards. He tried for a home equity loan since he has plenty of equity and high credit scores. His mortgage lender says he doesn’t make enough money and that he needs a co-signer.

He owes only $50,000 on the house and needs about $40,000 to pay off his bills. Why should he be punished for working hard all these years? This is crazy and stupid. Is a reverse mortgage the way to go for him?

Answer: Possibly, but it’s concerning that he has so much credit card debt. Too often people who tap their home equity to pay off debt wind up worse off in a few years. They don’t fix the problem that caused the debt in the first place, so they continue to overspend — but now they have less of a home equity cushion to fall back on in case of emergency.

That’s especially true with a reverse mortgage. These loans allow people 62 and over to borrow against their home equity without having to make payments or repay the loan until they sell, move out or die. However, any amount they borrow and don’t repay will grow over time, typically at a variable interest rate. People who use reverse mortgages to pay off debt early in retirement can wind up unable to access their equity later, when they may need it more.

The lender isn’t trying to punish your ex for working hard, by the way. It’s saying he doesn’t appear to have enough income to pay his mortgage, cover the new loan payments and take care of his other bills. Your ex may think the lender’s standards are too strict, and it’s true many lenders are more reluctant to lend to the self-employed. He may find another lender that’s more cooperative if he shops around. But that huge amount of credit card debt indicates a serious problem that needs fixing, and another loan may not be the answer.

Since your ex feels comfortable sharing financial details with you, you might suggest that he discuss his situation with a credit counselor (the National Foundation for Credit Counseling offers referrals) and with a bankruptcy attorney (the National Assn. of Consumer Bankruptcy Attorneys). Each can assess his situation and offer different potential options he could consider.

Monday’s need-to-know money news

Today’s top story: How to stretch your spending money in college. Also in the news, 4 places to find last-minute scholarships, why your house is not a piggy bank, and 6 financial microhabits that can make you rich.

How to Stretch Your Spending Money in College
Making it last week-to-week.

4 Places to Find Last-Minute Scholarships
You still have (a little bit of) time.

Your House Isn’t a Piggy Bank
Don’t treat it like one.

6 Financial Microhabits That Can Make You Rich
Even the tiniest habit can make a difference.

Your house isn’t a piggy bank

Your home equity could keep you afloat in retirement or bail you out in an emergency — but not if you spend it first.

U.S. homeowners are sitting on nearly $6 trillion of home value they could tap as of May 2018, according to data provider Black Knight. Lenders are eager to help many do just that through home equity loans, home equity lines of credit and cash-out refinancing.

The rates are often lower than other kinds of borrowing, and the interest may still be deductible, despite last year’s tax reform changes. But you can lose your home to foreclosure if you can’t pay back the loan, which is why financial planners generally frown on using equity for luxuries, investing or consolidating credit card debt.

Many planners point to the foreclosure crisis that started a decade ago as an example of what can go wrong when people binge on home equity debt.

In my latest for the Associated Press, why it’s dangerous to treat your house like a piggy bank.

Tuesday’s need-to-know money news

Today’s top story: How seniors can save money with discounts. Also in the news: Home equity borrowing and taxes, smart ways to save on car expenses, and the 3 times you shouldn’t ask for a raise.

How Seniors Can Save Money With Discounts
Every penny counts.

Is Interest on Home Equity Borrowing Tax-Deductible
Understanding the rules.

Smart Ways to Save on Car Expenses
Tips to find savings.

3 times you shouldn’t ask for a raise
When the timing is right.

5 Good Reasons to Tap Your Home Equity

496065-570x225-2Lenders want you to borrow against your home equity again. The question is, should you?

Rising home values and a sluggish mortgage market mean banks are once more marketing home equity lines of credit. Last year, lenders handed out $156 billion in HELOCs, a 24% rise from a year earlier and a 138% rise from 2010.

HELOCs are typically a cheap source of credit, with current rates averaging less than 5%. (Here’s how to pick the right HELOC lender.) But borrowing against your home equity can be risky. Rates are typically variable, and payments can balloon after the initial interest-only period ends. A recent uptick in second mortgage delinquencies is being driven by an 87% jump in missed payments from loans made in 2005 that just ended their 10-year interest-only period, according to Black Knight Financial Services, which tracks mortgages.

In my latest for NerdWallet, when it makes sense to tap your home equity.

Monday’s need-to-know money news

18ixgvpiu0s24jpgToday’s top story: How to save for retirement without a 401(k). Also in the news: Checking your 401(k) fees, the tax consequences of renting your home on Airbnb, and smart money moves for soldiers and military veterans.

5 Ways to Save for Retirement Besides a 401K
401(k) alternatives.

Why You Should Check Your 401(k) Plan’s Fees
Looking out for dents in your nest egg.

Renting Your Home On Airbnb? Be Aware Of The Tax Consequences
That extra cash could be costly.

5 Smart Money Moves for Soldiers and Military Veterans
Defending your finances.

Beware Lifestyle Inflation When Your Home’s Equity Increases
Avoid spending more.

Q&A: Paying down debt without touching home equity

Dear Liz: My wife and I accrued $28,000 of credit card debt over the past eight years. In addition to a sizable student loan bill for law school, our home mortgage and the expenses associated with three young children, we are struggling to get ahead enough to knock our credit card debt down. While we make good income between the two of us, it would seem not enough to pay more than the minimum on our debts. We have curbed a number of our bad habits (we eat out less, take lunch to work, say no to relatives) but the savings are not translating to lowered debt. Our 401(k)s are holding steady and we continue to contribute and I don’t want to touch those (I did when I was younger and regret it.). We’ve been considering taking out a home equity line of credit to pay off the cards and reduce the interest rate. Of course we have to be disciplined enough to not go out and create more debt, but I think my wife got the picture when I said no family vacations for the next few years. What are your thoughts?

Answer: You say, “Of course we have to be disciplined enough to not go out and create more debt,” but that’s exactly what many families do after they’ve used home equity borrowing to pay off their cards. They wind up deeper in the hole, plus they’ve put their home at risk to pay off debt that otherwise might be erased in Bankruptcy Court.

Bankruptcy probably isn’t in the cards for you, of course, given your resources. But before you use home equity to refinance this debt, you need to fix the problems that caused you to live so far beyond your means.

You’ve plugged some of the obvious leaks — eating out and mooching relatives — but you may be able to reduce other expenses, including your grocery and utility bills. If those smaller fixes don’t free up enough cash to start paying down the debt, the next places to look are at your big-ticket expenses: your home, your cars and your student loans. There may not be much you can do about the latter, although you should explore your options for consolidating and refinancing this debt. That leaves your home and your cars. If your payments on these two expenses are eating up more than about 35% of your income, then you should consider downsizing.

What you don’t want to do is to tap your retirement funds or reduce your contributions below the level that gets the full company match. Retirement needs to remain your top financial priority.

Reducing your lifestyle may not be appealing, but it’s better to sacrifice now while you’re younger than to wind up old and broke.

Friday’s need-to-know money news

School Kids DiversityWhy schools are lacking financial literacy classes, what retirees need to consider before buying a new car, and how to get the most from your wholesale club membership.

Why We Want—But Can’t Have—Personal Finance in Schools
Is financial literacy as important as historical literacy?

Should Retirees Finance a Car or Pay Cash?
Several things retirees should consider before getting behind the wheel.

10 Mistakes Even Savvy Stock Investors Make
Tweeter does not equal Twitter.

Don’t Count on Home Equity to Fund Retirement
Being realistic about the equity in your home.

Ways to Save: Best, worst buys at wholesale clubs
Do you really need that ten pound jar of peanuts?

Student loans may be better than home equity borrowing

Dear Liz: I am almost finished with my associate degree at my local community college and will be starting my undergraduate degree in January. I have been lucky enough to accrue no college debt so far but know I will when I start my bachelor’s degree. I am considering taking out a home equity loan to cover this cost, borrowing around $10,000. I got a great deal on my house and it continues to grow in value even with this economy. Your thoughts on this?

Answer: Home equity loans are actually more expensive than most federal student loans. Home equity loan rates for people with good credit range from 7% to 9% in many areas, while the current rate for direct, unsubsidized federal student loans is 5.41%. Furthermore, home equity loans aren’t as flexible and have fewer consumer protections than federal student loans.

You may initially get a lower rate on a home equity line of credit, but these variable-rate loans easily could get more expensive as interest rates rise.

Not only do federal student loans offer fixed rates, but they provide many affordable repayment options plus deferrals or forbearance if you should lose your job or run into other economic setbacks. You don’t have to demonstrate financial need to get federal student loans, although people with such needs can get subsidized loans with a lower interest rate. Your college’s financial aid office can help you apply.