With banks tightening their purse strings, through higher interest rates, homeowners may be tempted to use the equity of their homes to purchase additional property or pay off consumer debt.
It’s an emerging trend that is extremely worrying for financial expert Dave Ramsey, host of The Ramsey Show.
“Sell your stinking house and move away,” he advised a caller during an October episode who was considering a home-equity line of credit (HELOC) to finance a down payment on a second home. “You’re replacing one type of stress with another type of stress.”
What is it about HELOCs that impressed Ramsey so much?
Homeowners are increasingly attracted to HELOCs.
RubyHome, a luxury real estate brokerage, analyzed web traffic data and found that searches for the term “HELOC” had increased by 305% compared to the previous year.
In Ramey’s opinion, eliminating HELOCs is just “moving debt from one pile to another, with a lot of risk.”
Risk: There is a possibility of losing the house. HELOCs are backed by the value of the underlying real estate, so failure to repay the loan can result in foreclosure. And it’s not that HELOCs necessarily come cheaper than traditional mortgages.
For one thing, their interest rates are variable. “Do you know what they base the interest rate on?” Ramsey said on a more recent episode of his show. “Whatever they feel. It is completely mutable and not indexed by anything external.
Certainly, recent data supports Ramsey’s objections: According to the Federal Reserve, the average interest rate on a HELOC is 9.02% while the average 30-year fixed mortgage is less than 8%.
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Why are HELOCs so popular?
A report from the Urban Institute suggests that HELOC lenders may still benefit from the recently ended cheap-credit era. Homeowners who locked in extremely low long-term mortgage rates in past years may not want to give up those rates by selling their homes.
So those who want to access their accumulated equity may look for other ways – namely, temporary credit lines at higher rates – to protect their cheap primary mortgage.
Ramsey doesn’t accept that line of thinking. In fact, he is not a fan of any housing loan. He advises people to limit lifestyle improvements and pay cash for property whenever possible.
“Ultimately we want to be 100% debt free,” he said during the episode. “Instead of trying to find a time when it’s OK to take out a loan, let’s find a way to avoid it.”
In fact, about 23% of homeowners in the US own their property free and clear without a mortgage. These fortunate families are untouched by the debt cycle. Higher mortgage rates don’t affect them. They also have the flexibility to sell their home and buy another home for cash, which Ramsey suggests is what most people want.
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This article provides information only and should not be construed as advice. It is provided without warranty of any kind.