June 22, 2003|By Liz Pulliam Weston | Liz Pulliam Weston,SPECIAL TO THE SUN
American homeowners owe nearly $1 trillion on home equity loans and lines of credit, according to SMR Research, and they borrow an additional $100 billion each year through cash-out refinancings. This wave of borrowing has serious repercussions for homeowners' financial health, so this week's column is devoted to dealing with home equity and debt.
I've used up all equity in my home to pay off credit card debt, but now my credit card debt has grown again to $40,000. I have $49,000 in a 401(k) and was thinking of using that to pay off that debt, but I'm told that's not a good idea. Now I don't know what to do.
Cut up those cards.
Go do it right now, before you think of the million and one reasons you "need" credit. You have a serious spending problem, and you'll never beat it if you continue to live beyond your means.
Draining away your home equity means you've lost an important financial cushion in case of an emergency. You also have left yourself vulnerable in other ways. If you had to sell your home now, you probably would owe more than you could recoup because your proceeds would be reduced by selling costs. And if home prices declined, which they do from time to time, you'd really be in a pickle.
You also are putting yourself behind the eight ball in terms of retirement savings. Many people use the equity in their homes to supplement Social Security, pensions and other savings, through reverse mortgages or selling their homes and buying less-expensive ones. If you keep spending all your equity, that valuable option won't be available.
Now you're thinking of making matters worse by tapping a retirement fund. Loans from a 401(k) are risky, because if you lose your job you'll be forced to repay the loan quickly, or pay significant taxes and penalties on the money you withdrew.
More important, you need to acquire the financial discipline of paying your debts from your income. Borrowing is what got you into this mess, and you can't solve the problem just by getting another loan.
If you're having trouble, consider joining Debtors Anonymous. This group, based on the principles of Alcoholics Anonymous, aims to help spenders get control of their lives.
I'm buying a condo and have the option of rolling the purchase price of furniture into my mortgage. The furniture is high quality, which is what I want. Should I do this? I want high-end furniture, not low-end stuff that wears out in five years. But the high-end furniture stores make you pay everything upfront, which I can't afford. What do you think I should do - roll the furniture cost into the condo mortgage or just wait and buy it piece by piece?
You said it yourself: You can't afford this furniture. The fact that you can get it by borrowing doesn't change that fact.
You'll keep yourself out of a lot of financial trouble by remembering this rule of thumb: Don't borrow money to buy depreciating assets. That includes your car, for which you should pay cash if possible instead of taking out a loan. (See next response).
It makes sense to borrow money to buy a home because homes typically rise in value over time. It usually doesn't make sense to use a mortgage to buy something like furniture that will lose a significant amount of value the minute it's delivered.
Find inexpensive ways to furnish your home for now and save up for the stuff you want. You'll end up in better financial shape, and your home won't have that sterile "matchy-matchy" look that comes from buying every stick of furniture at once.
Our old car is on its last legs and we really need to replace it. Rather than buy a new car, we were thinking of getting a vehicle that's a couple years old and using our home equity line of credit to purchase it. That way the interest is tax deductible. What say you?
In the best of all possible worlds, you would pay cash for cars. Most people could afford to do so if they would simply drive their current car for four to five years after they make their last loan payment and put an amount equal to that payment in the bank each month.
Because your car is about to die on you, though, your plan is the next best thing. A gently used car will have suffered its worst depreciation (which typically happens the minute you drive it off the lot) and the after-tax rate you'll pay with a home equity line of credit is likely to beat your other options.
Do try to pay off the loan as soon as possible, though. Lines of credit have variable rates, and the low rates won't last forever. Also, you'll want to keep as much of your line clear as possible in case of financial emergency.
Liz Pulliam Weston is a contributor to the Los Angeles Times, a Tribune Publishing newspaper.
