This installment of the Debt Free Challenge covers the item that was largest in my debt snowball, the Home Equity Line of Credit, or HELOC.
What is a HELOC?
The HELOC differs from a Home Equity Loan or Second Mortgage in that it works much like a revolving credit card. A Home Equity Loan has a fixed loan amount, a fixed interest rate, and a fixed payment term. A HELOC allows you to draw off the line multiple times. Once you’ve paid back the principal of the line it becomes available for you to draw again. Additionally, the interest rate is typically not a fixed rate but varies with the current Federal Reserve rate.
History of the HELOC
According to Investopedia, Home Equity Loans and HELOCs became popular after the passage of the Tax Reform Act of 1986. While the law eliminated the tax deductibility of credit card interest, it did not change the dedictibility of mortgage interest. Financial institutions realized this and started heavily marketing Home Equity Loans and HELOCs by emphasizing this “loophole” in the tax law. Soon Home Equity Loans and HELOCs became widely available and easily obtainable since the borrower’s home was used as collateral for the loan.
Paying for Lifestyle
While I was researching the history of the HELOC, I found this interesting article written in 2008 by Felix Salmon. One line, in particular, jumped out at me:
“Contrary to fears that home equity loans would lead consumers to ‘pledge the house to buy a blouse,’ Mr. Capasse said, ‘there is very little convenience use of the accounts.’
“Obviously this was before the days when home-equity lines of credit started coming with credit cards attached, so that it was actually easier, at the margin, to ‘pledge the house to buy a blouse’ than it was to pay in cash.”
Sadly in a lot of cases, this is exactly what happened. The housing decline in the mid-2000s caused home values to plummet, yet borrowers were still on the hook for the loans they took out using their homes as collateral. While many of those loans were used for their intended purpose of remodeling and renewing their homes, just as many borrowers were using the equity in their homes to pay for lifestyle. During this crisis, and in the years since, over 6 million homeowners lost their homes to foreclosure.
According to this 2018 article in MarketWatch, 10 years on from the housing crisis many of the people affected are still feeling its effects. Their experiences serve as a cautionary tale to the rest of us. If you choose to borrow against your home to pay for lifestyle, do so with the knowledge that you may be mortgaging your future for what amounts to nothing. Your home is worth nothing more than what someone will pay you for it. Keep that in mind whenever you are tempted to borrow against your equity.
Current Tax Law
The Tax Cuts and Jobs Act of 2017, among other things, changed the way homeowners can deduct the interest on their HELOCs and Home Equity Loans. According to Bankrate, “Borrowers must use the money to build or improve their properties. And the deductibility of debt from mortgages, HELOCs and home equity loans is capped at certain dollar limits.” Don’t be tempted to take money out of your home to pay for a vacation as this is no longer a deductible expense. More can be found at IRS.gov.
Paying off your HELOC-Proceed with Caution
While I would advise you to add your HELOC or Home Equity Loan to your debt payoff strategy, I urge you to proceed with caution. In particular, be sure to read the terms of your loan and understand them fully before paying it off. In my case, I would’ve been responsible for the closing costs if I did not keep the line open for a set period of time.
Hindsight is a wonderful teacher. Knowing what I know now, I probably would not have opened a HELOC. While I did not go crazy with it, I very easily could have if I had not been careful. Having it paid in full is a HUGE relief.
Be well and God Bless-until we meet again…
Note-Any and all items contained in the Older Wiser Money Miser Debt Free Challenge are intended as a resource for informational purposes only and should not be construed as professional tax or investing advice.