Debt is a success killer. It prevents you from reaching your goals. As a general rule, debt is something you should avoid whenever possible. There are exceptions to the rule. But you have to be very careful.
One of the exceptions is a loan that can actually help you reach your goals faster. Of course, this same loan can also cause tremendous debt problems.
The loan is called a home equity line of credit. It is essentially a loan you take on the value of your home that's paid off. So, if you owe $100,000 on a $150,000 home, a bank will let you take out a line of credit on some percentage of that $50,000 you have in equity.
The money can be used for just about anything, but that's where most people get in trouble. The original purpose of these loans was to make improvements or additions to your home. In recent years, though, people have used their lines of credit to buy cars, boats, and vacations.
What's wrong with that? Unlike a conventional car or boat loan, which is usually three to five years, a line of equity's monthly payment is usually just a minimum payment, much like a credit card. The longer they can keep you in debt, the more money they make off of you. So you're going to pay a lot more in interest than you would with a traditional loan. Because most people pay only the minimum payment, it's conceivable -- and probable -- that you'll be paying off the car or boat many years after you've sold it.
Second, if you default on the loan, you don't lose your car or boat. You lose your house.
But, if you use the equity line of credit to build value in your home, it can be a valuable tool. Remodeling a kitchen or a bathroom, building an addition or finishing a basement can pay off big time when you sell the house.
Unfortunately, most of these loans carry variable interest rates. And when the rates go up, so do your payments. This can be a problem for budgeting and it can cause hardship if the rates go up fast.
The good news, though, is that two large banks Wells Fargo and Bank of America are now offering fixed-rate home equity lines. I suspect that more banks will follow suit. The current weakness in the housing industry has also hit the mortgage business. As a result, they're looking for ways to make their products more appealing. And this is definitely more appealing. At this point, you can only fix the rate on a portion of your loan. But I think that portion will grow as the product grows in popularity.
