In the week leading up to the Super Bowl on February 6th, Associated Press writer Michael Rubinkam reported that Eagles fans were calling local mortgage lenders to find out if they could take out home equity loans in order to pay for game packages.
According to Rubinkam’s story, one man borrowed $4,000 from his home equity line of credit in order to pay for a Super Bowl package that included round-trip airfare, four nights in a hotel and one (that’s right, just one) ticket to the game.
Why did he use his home equity line of credit? He had already maxed out his credit cards.
There’s nothing wrong with being a football fan. My plans for Super Bowl Sunday included spending the evening with friends in front of their big-screen television, eating too many carbs. But watch out when your passion becomes uncontrollable.
It’s one thing to take out a home equity loan to renovate your home. It can even be a good idea to use your home equity to pay down or pay off your credit card debts or auto loans.
But when you’re putting your home at risk for a three-hour thrill because you can’t get the cash anywhere else, it’s time to think hard about when you’re going to start making smarter moves with your money.
Of course, the way home values have been rising, you might think there’s enough home equity to go around.
Nationwide, home values rose about 13 percent last year. If you were lucky enough to live in Florida or Southern California, you might have seen the value of your property rise more than 20 percent. If you lived in Las Vegas, the average property rose 41 percent in value.
So if you bought your home for $300,000, you might expect the value to be about $336,000 — unless you live in Las Vegas. Then you might imagine your home is now worth $423,000.
Even if your home value rose just $10,000 last year, you might not think twice about digging into that equity to pay for things like home improvements, college tuition or, yes, Super Bowl tickets.
But there’s actually a big a difference between using your home equity to pay for a home improvement, or college tuition and using it as a checkbook to fund a weekend’s worth of entertainment.
Using home equity cash to upgrade your home or pay for a renovation means you’re investing those funds back into your house. If you make savvy choices, that investment in your home typically translates into increasing the overall value of your house over time.
It’s like a company that reinvests its profits into the business. If you make a smart investment, the company will grow. Likewise, a smart investment made in your home, like upgrading the kitchen or adding on a master bedroom and bath, will make your home worth more — hopefully more than you’ve spent.
When you use your home equity to pay down debt, you’re also making a smart investment in your financial future. For example, if your credit card has a $5,000 balance on which you’re paying 15 percent each month, every dollar of that debt you pay down means you’re effectively earning a 15 percent return on that dollar. If you pay the balance down to zero, you’re effectively earning 15 percent on that investment.
If you use home equity cash to pay down a credit card balance, you’re benefiting in a couple of ways. First, you’re trading non-deductible debt for deductible debt. The interest you pay on credit card debt cannot be deducted from your federal income tax return if you itemize, whereas the interest you pay on home equity loans, lines of credit and mortgages can be deducted, up to certain limits.
More importantly, the interest rate on a home equity loan or line of credit is likely to be substantially less than what you’ll pay on a credit card. So, your payment will go down. If you then keep paying the same amount that you were paying previously, you’ll really start to make headway in paying off that credit card debt.
But when you use your home equity line of credit to pay for entertainment or even your regular expenses, you’re not investing the cash — you’re simply spending it. The idea of “living within your means” becomes moot. Instead of treating your home equity as something sacred, it becomes just another pot of cash to tap.
And one day, that pot may just run dry.
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