Recently, I was on a business trip to give a presentation to some young airmen on building a strong financial future. Pacing back and forth in my hotel room, I ran through the presentation in my mind, with the TV on as background noise. Suddenly, a sound bite from an on-air commercial stopped me in my tracks. With more than a little enthusiasm, the narrator exclaimed, “Your house is your bank.”
Wow. I had been down this path before – and not with good results. Just a few years into my financial planning career, I was working with a couple who had accumulated around $25,000 in credit-card debt. Unfortunately, I made a recommendation that addressed the symptom – a whole bunch of high-interest credit card debt – without touching on the root cause: out-of-control spending. You can see where this is going: With my assistance, their house had become their bank.
About six months later, I stopped by their bank – er, house – to check in on their progress and was quite dismayed to see that the “bank” had apparently needed new windows, and one of the employees plastic surgery. When all was said and done, the couple had worked diligently to rebuild their credit-card debt to its previous level and – thanks to my guidance – had a big home-equity loan to boot.
This is not to say that a home-equity loan can’t make sense in certain situations, but here are a few questions to ask yourself before you move forward.
Am I banking on the tax benefits? Until the arrival of last year’s Tax Cuts and Jobs Act, you could deduct home equity interest up to $100,000 for home equity loans or lines of credit used for any purpose – including paying off debt. No more. The new law eliminates the deduction on this type of interest. So from a tax perspective, it’s now less attractive to tap the equity in your home.
How did I get here? There are many reasons you could have ended up with a pile of debt. If one of those reasons is plain old overspending, and you’re looking for a silver bullet, stop. As happened to my clients, it’s possible you’ll put your home at risk and add more debt. Look in the mirror, figure out how you got where you are, and ensure you’ve got a game plan to manage your (over)spending.
Am I picking the right product? If you’re using the equity in your home as a financial resource, there are two basic approaches: a line of credit and a loan. A line of credit is just that: It provides something you can draw on when you need it via checks or electronic transfers. This approach might work well if you’re using home equity to fund periodic, but unknown expenses such as education. Interest rates typically fluctuate with market interest rates. A loan, on the other hand, will have a set repayment schedule, a fixed interest rate, and a clear beginning and end. A loan would work best for a one-time expenditure, such as debt consolidation.
Am I creating value? Why do you need money now? Are you taking a vacation or buying a luxury item? If that’s the case, you don’t want to “make your house your bank.” On the other hand, you could make a case for funding education, home improvements or other moves that add long-term value to your financial situation.
I’ve stopped pacing. But let me get it off my chest one more time: Your house is your home, not your bank.
J.J. Montanaro is a certified financial planner with USAA, The American Legion’s preferred provider of financial services. Submit questions for him online.