This season, many consumers will charge against the home for the holidays. They will use home equity debt to pay for gifts and travel.
Home equity debt traditionally has been spent on investments that bring some kind of return -- renovating houses, paying for college, starting small businesses. More recently, as consumers have become more clever about using debt, equity loans have come to be seen as a cheaper, smart way to consolidate debt and pay for long-lasting things such as cars and furniture.
But gifts and airline tickets to visit family?
Believe it or not, bankers and consumer advocates agree that there are times when it's appropriate to pay for something so fleeting by charging it against the roof over your head. It's not exactly wise to go into debt to pay for presents, but if you're going to do it, you might as well do so as inexpensively as possible.
"Don't let these things be excuses to be in debt. That's the issue," says Anthony Hsieh, president of Home Loan Center, an online lender based in Orange County, Calif.
Home equity loans, also known as second mortgages, come in a lump sum. You repay them with equal monthly payments at a fixed rate for a specified period.
Home equity lines of credit, or HELOCs, work like credit cards. Instead of getting a lump sum, you start out with a credit line, and you can draw up to the credit line's limit. During the first years of the account, the minimum monthly payment covers only the interest on the balance. The rate is variable and usually is tied to the prime rate.
On both kinds of equity debt, the interest you pay is deductible from your federal income taxes in most cases.
That's the key, Hsieh says. If you decide to take some time to pay off your holiday debt, why not do it with tax-deductible interest?
"Is it irresponsible to dig into equity [to pay for gifts?]" Hsieh asks. "Yes. But if you're going to get into debt and you're disciplined enough to pay it off in a predetermined time, there is an advantage to using a HELOC because the interest is deductible."
Rudy Cavazos, spokesman for Money Management International, a national credit counseling agency based in Houston, agrees that buying things with low-rate home equity debt "beats using that credit card" with higher rates and no tax-deductibility. But he's not sure every consumer understands all the differences between regular credit cards and cards tied to HELOCs, including the biggie: "You're placing your home on the line as security, as collateral, for these funds."
Sure, the HELOC has a lower rate and the interest is tax- deductible. But the regular credit card is unsecured, meaning that the balance is not backed by collateral -- so the debt can be wiped clean in some bankruptcies. Not so with a card tied to a HELOC. If you buy your godson a Christmas gift with your HELOC, you are pledging your house as collateral. You can't walk away from the debt, even in bankruptcy.
This important point might not be stressed at the time of the loan application, and that's why Cavazos recommends that consumers get some kind of loan counseling before they take out home equity loans or get HELOCs. Consumer credit counseling agencies such as MMI often hold workshops or do one-on-one education for people who get home loans of all kinds.
Cavazos hears radio advertisements all the time that tout home equity as a way to consolidate debt "or improve their lifestyle in some way. That's all good, but you have to remember to educate yourself before you enter into these types of financial tools."
The best financial tool is to stay away from debt in the first place. Instead, use the financial tool that can't be beat: a savings account.
E-mail Holden Lewis at email@example.com.
Scripps Howard News Service
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