If You Can’t Pay Cash, You Can’t Afford It
If you can’t pay cash, you can’t afford it.
Ugh. I sound like my dad.
Not that that’s a bad thing. My dad’s a pretty smart dude. But still. Lots of people would argue against what I just stated so matter of factly. They’d tell you that you it’s okay to borrow money. That it’s expected. That as long as you pay off your bills/loans each month, you’re in the clear.
I’m going to disagree.
Once again. If you can’t pay cash, you can’t afford it.
I was talking to a friend who had mentioned wanting to take out a home equity line of credit (HELOC) to do some renovations on their house. Update the floors, redo the kitchen, etc…
I will fully admit that my initial thought was, “OH NO! That’s a terrible idea!” My friend asked me why and I sputtered for a bit before just saying, “Well, because it is.”
So I decided to do some research. You all get to benefit from my single-mindedness. Hope you’re happy.
First things first. What is a HELOC.
Basically, a HELOC is a second mortgage. You’re borrowing a line of credit against the supposed equity in your house. You have to pay back any money you borrow from that line of credit, plus interest, or the bank could use your house as collateral. If you default on your loan, you could lose your house!
As I was digging into this, my research pulled up a few red flags that suggest that maybe opening one of these home equity lines of credit aren’t the best financial idea in the world.
Red Flag #1
First, when you google “HELOC” you get about a page of google results from different banks explaining how easy it is to take one out and why it is such a good idea. I got four ads and six different banks offering lines of credit before I even got to the wikipedia article defining HELOCs.
Not good guys. Predatory practices right there.
Red Flag #2
The wikipedia article on HELOCs notes that overuse of HELOCs was one of the causes of the sub-prime mortgage crash! SHIT!
A little digging into the footnotes and some better Google-Fu turns up a few more articles that actually suggest HELOCs might cause another crash as they reset, damaging the housing market further. As well as some cautionary tales.
Red Flag #3
A HELOC is a home equity line of credit. While the housing market has been on the rebound since it crashed back in 2008. It’s far from stable. There are a lot of things that suggest that using your home as an investment vehicle or a source of cash (equity) are just not wise practices in today’s day and age.
Red Flag #4
Taking out a HELOC means that you do not have the cash on hand for any renovation you might want to do. If your income is at all unstable, you’re a bad saver, or you would be in trouble if interest rates increased (and they’re variable, so they could) a HELOC is not for you.
I’ve talked about automating your savings goals before, but there is no real reason you can’t also save for bigger, long-term goals. In fact, I’d suggest that you DO save for those goals. A HELOC can seem like instant gratification – I want to renovate my house now – but that instant gratification is only hurting you in the long-run.
Think about how much more pride you’d have in your renovations and updates if you saved for them yourself and worked hard to achieve a goal that was important to you!
Think long and hard before taking out a HELOC. I know I’ve kind of shit on them above, but I do think that there could be instances in which it might make sense to take out a HELOC.
If you’ve been in your home awhile, have paid down your mortgage, and are 100% confident in the fact that you do have some equity to borrow against, a HELOC could make sense.
Particularly, if you have a fully funded retirement package going for you, a healthy emergency fund, and the ability to make your HELOC payments each month even if the interest rates go up.
If you are planning to stay in your home forever (and I know many people who purchase a home with the intent of it being their “forever home”) then it might make sense to use a HELOC to do the upgrades you’d like. If you plan to move, however, then you’re sinking money into a home and you might not ever see a reasonable rate of return on it. It’s true that kitchens and bathrooms sell homes, but just because you spend 40k on a kitchen doesn’t mean you’ll see an extra 40k when you go to see.
However, if you do intend to stay, it might actually make sense to take out a HELOC, because your money could potentially make more money in investment vehicles then sitting in a savings account earning less than 1% interest while you save enough to do your renovations.
Does that make sense?
There’s A LOT to wrap our heads around here. I suppose the biggest thing to consider when thinking about taking out a HELOC is that you really do need to do your homework. Do not let the idea of shiny new appliances or that jetted tub you’ve been coveting convince you that a HELOC is a necessary vehicle for renovations or upgrades to your home.
Plenty of people plan in advance for those types of upgrades and save money specifically for them. You can too!
I think it’s also important to ask yourself if the renovations and upgrades you want to do will solve a problem you’re having in your house. Redecorating a space doesn’t necessarily make that space functional or put you in a better school district. In the amount of time it might take you to do those renovations you could save a reasonable amount of money and buy a new house that might fix the issues you’re trying to address via renovations.