Using your house to pay credit cards? Cashing in your retirement savings to pay medical bills? Why those actions may cost you more in the long run.
Not long ago, one of the attorneys in our office was meeting with a potential client who faced foreclosure on a home equity loan. It was a sad and avoidable situation caused in part by desperation and in part by a lack of information.
Until 2000, homeowners in the state of Texas had little opportunity to mine the equity in their homes. Until then, borrowers could only get equity loans on their primary residence to pay property taxes or make home improvements. Since Texans approved the law making home equity loans more available, homeowners can take out home equity loans for just about whatever they desire: adding on a room, buying a car, paying for schooling, you name it. Many banks offer home equity lines of credit that can be accessed with a debit or credit card or a checkbook.
Now, we’re seeing more and more homeowners tapping into their biggest investments to pay credit card balances and other dischargeable debts, often in the guise of “consolidation” loans. Lenders make it sound so easy. All you have to do is use the equity in your house to pay off your other debts, then make one low monthly payment to the equity lender, often less than the total of the monthly minimums to the credit card companies. No more robbing Peter to pay Paul. Sounds heavenly, yes?
Unfortunately, for many that strategy just doesn’t work. Once the credit card accounts are cleared, borrowers who are accustomed to using plastic often find that breaking the cycle is next to impossible, especially if the cards are handy and the accounts are not closed. Before long, the balances are back up, and borrowers are struggling to pay not only their credit card minimums, but that “low” monthly payment to the mortgage company as well.
And to make matters worse, the borrower has turned dischargeable debt into secured debt. That means he’s put up his house as collateral for the money to pay off those credit cards. A home equity loan is a mortgage. If he doesn’t pay the mortgage, the lender can foreclose and throw him out. In other words, he’s putting his home on the line often to pay nothing more than interest that has accumulated on years-old purchases of consumables (like restaurant meals) and services (that vacation to Cancun five years ago).
We certainly understand why people put their homes in jeopardy (oh, they don’t think of it that way, but that’s the upshot). Often strapped for cash and burdened by harassing collection calls, using the equity or retirement savings they’ve amassed over the years seems like an easy fix. But, even if they don’t fall into the trap of allowing their credit cards to get out of hand again, they’re still vulnerable to a fickle job market or unforeseen medical issues that could cause financial chaos. Just look at the number of people affected by the Great Recession of 2008 (and 2009, 2010, 2011 and 2012).
So, are there any alternatives to raiding the nest egg to pay back unsecured debt? Tune in next time to learn ways to retire your unsecured debt while saving your assets.