HELOC Abuse
by Richard
Every cloud has its own, unique silver lining.
The banks are in full retrenchment mode, and are proactively shrinking, or cancelling altogether, home equity lines of credit (HELOC) in markets hard hit by free falling housing prices.
This follows closely on the heels of their earlier cutbacks to credit card holders.
Americans love their credit lines, so predictably they are howling with outrage.
Count Your Blessings
These high limit credit lines are to debt abusers what an open bar tab is to alcoholics. An invitation to compound the abusive addiction.
For background and context, check out the Wall Street Journal article “Renovators in Limbo” by June Fletcher (6/27/08, W8) and “In the Latest Chill for Homeowners, Banks are Freezing Lines of Credit” by Amy Hoak (7/1/08, D6).
The first article highlights problems faced by homeowners in the midst of major home renovations, and how they have had to scramble to complete jobs after their credit lines were shut down.
The second article totally pole-axed me….starting with the lady whose check bounced when she tried to buy some basic home furnishings written on her just-canceled home equity line of credit.
How did it ever come to pass that a homeowner would pledge their most important investment as collateral to buy consumer durables?
My conclusion is simply that the presence of the credit facility induced buying behavior that would never have transpired, had it not been for the availability of the credit.
In other words, once consumers were armored up with their plastic and HELOCs, they went charging into debt…not understanding that credit is a force to be held in reserve for when it is ABSOLUTELY needed.
They could not stand by idly, without maxing out to the hilt.
Back to Basics
The reason to borrow is to cover a genuine financial emergency, or to obtain positive leverage with the borrowed funds. But this madness of borrowing to indulge impulse buying of items guaranteed to depreciate is both pernicious and backwards.
Positive leverage in plain English means that the acquired asset(s) will appreciate at a greater rate than the cost of the borrowing.
In general, positive leverage results from careful and prudent borrowing…
- To launch or expand your own business.
- To buy a home. Just the down payment. The house should appreciate at the inflation rate over the long run. Not the absolute best investment you can make, but emotionally satisfying and a guaranteed long term forced savings plan as you amortize the mortgage.
- To complete your or your children’s higher education, resulting in vastly increased lifetime earnings potential.
That just about covers all the legitimate reasons to borrow.
Not a very long list, is it?
Reality Check…
There is no home remodel that will return its cost. Consider yourself lucky if you can recover at least half of the sum spent.
There is no recovery on depreciating automobiles, exotic vacations, or household expenses normally funded from employment income.
And please don’t tell me you borrow because the interest is deductible. If you are desperate for a deduction, take the plunge and launch your own business, and write off your inevitable start up expenses.
At least go down swinging.
