Should You Use Your Home as an ATM?

Here we go again.  According to Black Knight Financial Services, cash-out residential refinances jumped 68% in the second quarter from a year ago, the highest volume of this type of refinancing in five years.

As home values increase, homeowners are seeing paper increases in equity, which, when combined with unusually low mortgage rates, creates an attractive opportunity to obtain funds for other major purchases, such as autos and home remodeling.

This is not necessarily a bad idea, if done carefully while retaining significant equity.  One would like to think that, given recent experience, lenders would be more careful in approving loan applications and seek to require substantial equity.  Unfortunately, government agencies have begun to express concern regarding “excessive caution” among lenders, thus allegedly denying access to funds for some would be borrowers.

Perhaps of greater concern is the increasing interest in debt consolidation loans using home equity.  With a debt consolidation loan, you combine all of your high interest rate debts (credit card) into a single lower interest rate loan.  Combining your debts with a debt consolidation loan allows you to lower your monthly payments and makes it easier to afford your monthly bills.

The down side of this strategy is, that by combining your debts, you have moved your unsecured debts (typically higher interest rate) into secured debt (secured by your home), which puts you in considerably more danger of losing your home.  Secured loans, for most consumers, auto loans and home mortgages, are subject to repossession of the collateral if you fail to make payments.  Credit card and other unsecured debts do not carry that risk.

Probably the highest risk strategy is the offer to lend you 100% of the value of your home, consolidating your secured and unsecured debt, and providing, in some cases, additional cash.  Yes, you will probably reduce your monthly payment and have new cash to spend, but any failure to meet your monthly payments can result in your losing your home.

Managing your finances is not easy.  An advisor can help.  In any event, be sure you understand the implications of what is proposed.

All comments and suggestions are welcome.

Walter J. Kirchberger, CFA®