Tuesday, September 23, 2008

Take The Equity Money And Run?

Withdrawing all your home equity loan cash is new financial disaster preparedness advice that may not be as radical as it sounds. However, some say it's risky "pretzel logic" business and the fundamentals should still apply when it comes to using what's likely your most valuable asset as an ATM.

Also see: "What To Do If Your HELOC Freezes Over"

by Broderick Perkins
© 2008 DeadlineNews.Com
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Deadline Newsroom - If hard times loom and you have a home equity loan, consider tapping it out now. Withdraw all you think you'll need and squirrel it away -- just in case.

That only sounds like radical mattress-stuffing financial advice.

Homeowners have long had hammered into their heads that home equity is best used for capital improvements -- investments with a high probability of a decent return -- or, perhaps, for emergencies. Otherwise, leave it alone.

But in the new credit-starved economy old axioms don't always hold sway. Not everyone agrees to an equity-grabbing approach, but there is a consensus among financial experts that your lender could grab back your equity loan money if you don't grab it first.
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"My understanding is that all banks are moving to de-leverage to reduce the amount of loans outstanding. They are reducing their commitment on home equity loans. If you think you will need it, it's a good time to take advantage of it before it goes away," said Bob Kresak, a certified financial planner and managing partner of the Silicon Valley headquarters of a financial planning and wealth management firm, Founders Financial Network, in Cupertino.

In an economy plagued by failing financial institutions heavily invested in mortgage securities and real estate, with investors fleeing "ultra-safe" money market mutual funds and with the Federal Reserve and U.S. Treasury Department asking Congress to pass a $700 billion bailout package for the nation's choked credit market, advice to homeowners to secure their home equity isn't surprising.

More advice to grab equity money and run also comes from the CMPS Institute, an organization created to certify mortgage bankers and brokers who counsel consumers on mortgage and real estate equity management, as well as home loans.

"A lot of lenders in San Jose and the San Francisco area are cutting off or reducing the credit limits on lines of credit so they can limit their exposure to all outstanding lines of credit," says Gibran Nicholas, chairman of the CMPS Institute.

"If you counted on an unused home loan line of credit for liquidity and safety, this is not a smart strategy, if you need it in this environment. Draw it all out now and put it an FDIC-insured account and have access to your money when you need it," he advises.

Nancy Osborne, chief operating officer at the Santa Clara-based online mortgage brokerage Erate.com, isn't so sure an equity money grab is the right thing to do. She says once a homeowner draws on a line of equity, payments begin, with interest.

"Home equity isn't free money after all. The entire concept sounds like pretzel logic. Isn't the fact that our economy has been over-leveraged by debt what got us all in this mess in the first place?" asks Osborne.

Also if you snatch all the equity and max out your home equity line of credit you could lower your credit score if only by a few points. Those few points may not be enough reason not to max out your home equity, if your lender reneges on the credit. If you have a home equity line of credit at, say $50,000 and you've used $20,000 and the lender decides to cut your limit to $2,000, it looks to the credit scoring computer like you've maxed out you home equity anyway.

Proponents insist the advice really isn't a radical shift from the fundamentals. The new advice just allows you to keep your home equity loan in a more liquid state. And from Wall Street giants to Main Street homeowners, today, liquidity is key.

Home equity is the difference between the value of your home and your mortgage balance. When you buy a home with a down payment of, say 20 percent, you have a 20 percent equity stake in your home. For example, if you buy a $500,000 home and manage 20 percent down, your equity stake is $100,000. In the past, such a position would allow you to borrow against that equity and obtain a second mortgage or home equity loan for as much as $100,000 or more.

The "more" was because equity can increase over time, due to mortgage payments that pay down the mortgage balance and appreciation -- the result of positive supply and demand market forces increasing the value of your home.

Unfortunately, depreciation -- negative market forces -- can reduce your equity stake, as is the case for many property owners in today's market.
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Today, risk averse lenders are suffering the financial fallout of foreclosures due to over-burdened homeowners -- some of whom already tapped too much equity. Evaporated equity forced lenders put the squeeze on how much you can borrow against your equity. Few lenders are willing to allow more mortgage debt (your first and second mortgages combined) than 80 percent of the value of your home.

"You are going to have a tough time now getting a line of credit. The appraisal has to come in at the right value. You'll have to document your income. It's a much bigger deal to get one today than it was six years ago," said Nicholas.

But even if you can get it, lenders can just as quickly take it away. If you don't use it, as the saying goes, you can lose it.

Otherwise, there are two older schools of thought on home equity use.

The most conservative approach suggests leaving your home equity in place. The idea is to eventually pay off your mortgage and when you are retired and living on a fixed income you'll be home free with no mortgage payment. Along with the fixed income and retirement investments, you'll also have the home's equity to tap should the need arise. All that's fine if you never need your equity until your home is paid off.

A less conservative approach to home equity use surfaced in recent years, due to generally softening economic conditions, before the housing crash. This approach suggested, even if you didn't need to spend the money, it wasn't a bad idea to take out a home equity loan anyway to tap during hard times or emergencies.

The strategy came in handy, especially for those facing pink slips. If you waited until you were unemployed and attempted to get a second mortgage and the lender checked for income, your application likely would have been rejected. However, if you already had a home equity loan you could use it to drive around looking for a new job all while maintaining the household budget.
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Likewise, if you are suddenly out of work, using home equity to consolidate other bills -- provided you cut up all the credit cards and actually close the accounts -- can also give you some financial breathing room.

A equity loan bird in the hand (held or tapped) is also frequently advised for emergencies, including unexpected medical care, especially among older homeowners who have few if any other visible means of support.

In any event, that less conservative strategy to get an equity loan in place -- just in case -- has evolved today into an even more disaster-preparedness approach. Don't let your home equity loan or line of credit just sit there. Tap some or all of it and sock it away, safely, so the lender doesn't take it back.

"If you are not disciplined and you go out and blow the money, of course this is not a good idea," said Nicholas.

Quincy A. Virgillio Jr., president elect of the Santa Clara County Association of Realtors says while an "equity depletion strategy" can be a way of saving an asset from declining value, it is risky business. He says equity use should come with a return that's greater than the cost of borrowing.

"And that's something that may be hard to achieve given the current yields that are being earned in today's markets. It becomes an issue if the returns are eliminated or diminished, making this a risky proposition," said Virgillio, also broker owner of the Mortgage Network in Campbell.

Generally both conservative and more liberal financial experts alike agree, that if you've got equity to use and don't need to hold onto it as a safety net, the best use is as a prudent capital investment.

That includes home improvements with high cost-vs-value returns, education for the kids, financing a sound new business, and other financial moves that have a good chance of providing an equal or better return on your money than the cost of the loan.

Avoid buying big gas guzzling cars, boats, RVs, vacations, home theaters and other items that don't give you a return on your money.

"That's where a lot of people went wrong in recent years, blowing it on vacations and new boats, products and things that weren't going to give value in the long term," Nicholas said.
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Today, if you can afford it, buying another home or real estate investment property, while prices are down and falling, can be a good capital investment use of your equity, but only over the long haul, five, 10 years or more.

You'll have to be sure any rental income will offset all or most of your carrying costs until home appreciation returns, or you'll have to have some other means of carrying the investment risk until it pays off. When that will be is anyone's guess.

"To some extent we would never advise someone to borrow money to invest. The example being that of Bear Sterns, Lehman Brothers and Merrill Lynch who were less prudent than most and leveraged themselves 50 times over and when the market went down, it caught them in the squeeze," said Kresak.

"It (a real estate investment) definitely isn't a one-time, short-term profit operation. You'll have to be in it long term. It is a good time to get in the market, but it could still go down further," he added.

Also, don't forget. When it comes to equity loans, even when you do use it, you lose it. A home equity loan, by it's very nature, is an equity-depleting loan.

• From the Deadline Newsroom, read more home equity news that really hits home.
• Also visit DeadlineNews.Com's Home Equity Center.

© 2008 DeadlineNews.Com

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Broderick Perkins, an award-winning consumer journalist of 30 years, is publisher and executive editor of San Jose, CA-based DeadlineNews Group -- DeadlineNews.Com, a real estate news and consulting service and Web site and the new Deadline Newsroom, DeadlineNews.Com's news back shop. In both cases, it's news that really hits home!

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