Should I Open A Home Equity Line of Credit? – Episode 197

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[00:01] Welcome to the Prosperity Podcast, fresh alternative personal finance talk for independent thinkers who prosper outside of Wall Street. Here’s your host, bestselling author, Kim D.H. Butler and No BS Money Guy, Todd Strobel. Hey everybody, welcome back to the Prosperity Podcast. This is No BS Money Guy, Todd Strobel. Once again, we have bestselling financial author and our co-host, Kim Butler with us today. And today we’re going to be actually discussing a question that came in from one of our listeners, which is one of our favorite things to do. And, of course, if any of you are wondering, we never use names or anything like that, so there’s no embarrassment or anything, but I’m going to read what the what our listener

[00:52] wrote and then we’ll just kind of go from there. It says, I have recently learned that I can trade my traditional mortgage for a home equity line of credit at no extra cost and was wondering what you see as the pros and cons of this. It is attractive to me because my mortgage is in its second year and I have over one hundred thousand dollars in equity, but can only tap into about fifteen K of it. If I switch, I still owe the same amount, but it would have access to seventy five thousand. Hope this topic interests you and would love to hear your insight. Thanks. Now, there’s a second part to this. Kim had asked some additional questions that I think are appropriate to kind of paint a better picture.

[01:49] And this was his response. I have a three point six to five percent of fixed three point six to five percent and the the home equity line of credit my bank is offering is at four point two five. But I have been negotiating with them trying to explain that it would be a first mortgage. But after listening to a couple of your books, there may be more tax advantage there. Couple question marks. The rest of the idea is to deposit my whole paycheck directly into the home equity line of credit and then borrowing from it to pay my monthly yearly bills. Daily weekly expenses go on the credit card and then it’s paid off at the end of the month every month. This plans takes planning and discipline. But at least when I pay money to the home equity line of credit, I can borrow more

[02:48] money every week, month, year, whereas a mortgage, it just goes to the bank. Hopefully, this would give me more liquidity and allow me to take advantage of investment opportunities that arise. Jim. Awesome question. I’m so glad it’s come up because this is something that a few other clients have asked about and I want to help everybody understand what’s going on here. And so a couple additional facts that I know from some email conversations back and forth is that the first mortgage was at about three and a half percent. And this second mortgage or the home equity credit line that would end up becoming both the first and the second mortgage is at four and a half percent. So right off the bat, it is not at the same cost.

[03:43] OK, you could argue that there’s not a big difference between three and a half and four and a half, but there is still a difference. And so we want to be really clear on that going into it. More importantly, we must realize that when these types of strategies are presented and oftentimes we have to pay extra for gaining, I guess is the taking on this strategy, we must realize that there are extra dollars going into this environment, whether it’s extra to pay the fee to actually get the capability to do this or it’s just extra dollars because of the money that is running through this scenario. And so we have to step back and say, OK, let’s look at the underlying product, which is debt against our home.

[04:46] And we have to ask ourselves, do we want that reduced faster? And I’m going to say an emphatic no. If you would like proof of this, we have a very thorough discussion of this issue in our Busting the Interest Rate Lies book, and it’s one of the books that’s available on Amazon, and it’s one that I would actually recommend people get a physical copy of. And I know a lot of people, especially our podcast listeners, really like the audiobooks, and I understand that. But in this case, I think a physical copy is going to be helpful because I actually use all of the calculators to prove numerically that putting extra money against a mortgage is not a good strategy. And so it doesn’t matter whether it’s extra money against a home equity line

[05:44] of credit because you’re running your, quote, expenses through or it’s extra money by prepaying a mortgage or extra money by making 13 payments in a year or extra money by making biweekly payments. It’s all the same thing. It’s extra money into a mortgage. And as a general rule of thumb, just speaking numerically and financially, that is not a good strategy. So, Todd, help me flesh this out a little bit further because I know people have questions in this area. Well, I think one of the deceptive things that, I hate to use the word deceptive, but we’re looking at a 3.6% fixed rate versus a 4.2% home equity line of credit. So there’s going to be some listeners out there who are going to think,

[06:35] well, I don’t want to pay a higher rate of interest. The thing that I’d like to propose is that if you had a 3.6% fixed interest rate and had a chance to borrow a 3% home equity line of credit, the fact that we’re able to borrow at fixed interest rates and the home equity line of credit is at a variable interest rate, even if we could lower our interest rate, would it make sense? And that’s a really good point. And my answer is no. If you can lock in a fixed rate at, frankly, anything under 8%, 8% has always been our dividing line. 8% or less, make it fixed. If it’s more than that, you probably want variable in the hopes that you could get it back down to a lower rate, but you always want to go for

[07:35] a fixed rate loan if you can, especially because the variable rate loans are often put out there as teasers, and consequently, they’re often only good for a year or two. And then you risk having that variable loan rate change and end up going higher than the fixed. So that’s a really big issue that leads us back to saying, no, keep your first mortgage, continue to make your payments there. And then we have also just the issue of how a home equity line of credit is handled at the banks versus a first mortgage. And I have to admit, I don’t know about this for sure. It would be different, possibly, at every different bank. But the first mortgages are first mortgages. I mean, there’s a reason that they’re first.

[08:26] They’re actually a mortgage, the deed of trust and everything that is assigned to them, whereas a home equity credit line is typically set up a little bit differently in terms of collateral. And so if it was supposedly acting as your first mortgage, I would want to know, does it mean that the bank could still, like they can on home equity credit lines, but they cannot on first mortgages, call the note? So a home equity credit line, because it is a line, the bank can just call those. And we saw that happen in 08 and 09. And they can either make it so that you cannot add any more to it, or they can literally ask you to pay it off. And I don’t think with a first mortgage, they can do that anymore.

[09:18] Is that your understanding as well? I mean, it’s absolutely correct. There were, you know, after the Great Depression, you know, there were people that literally owed hundreds of dollars on their house. And all notes were callable back then. And it was such a disaster because, you know, which houses did the banks foreclose on? They foreclosed on the ones that they could make a profit on. So it was the people who owed a little that suffered the worst. And there was some change in legislation that required first mortgages cannot have a arbitrary call in them. Now, you can have a three-year balloon, a five-year balloon or whatever, but it’s terms that are negotiated up front. Now, on the home equity lines of credit, it really is in the banks

[10:19] favor, they can pretty much do anything that they want to with them. Now, your interest rate is tied to an index, so they can’t just say, hey, Joe, your interest rate is going to be 10. Hey, Dave, your interest rate is going to be 12. They can’t really do that, but they can stop lending, stop, like you said, stop allowing new draws on home equity lines of credit. And more importantly, they can ask for the money back. And, you know, I happened to be working at a bank in 2008 and to have, you know, 20-year relationships with clients that come storming in because they depended upon their home equity line of credit as an emergency fund, which I think is another great point to make here, is that you

[11:06] never want to have borrowed money as your emergency fund. Yes, it is interesting. I’ve on occasion been okay with somebody saying that they have available credit as their, like, second emergency fund, like, okay, they have some cash value and life insurance policy, or they have cash in the bank. And then they also have a credit card that’s empty or a home equity line of credit that’s empty. And I’m all for having home equity credit lines. That they’re a fabulous strategy. And yes, there are definitely people that would use them and be at peace with them being their emergency opportunity fund or maybe their second emergency opportunity fund. There are other people, as this particular person referenced, that

[11:55] would be comfortable borrowing against their home equity line of credit and investing, but I think that needs to be done very, very carefully. There are definitely people that are comfortable with it. There are definitely investments out there that people would be confident enough in to have that structure. But as a general rule, I don’t think we want to be taking on debt to invest, we want to be using our own money to invest. And then looking at debt as definitely a way to leverage, but more in the event of a piece of property that is attached to that debt, of course, ideally one that’s even rented out, like investment real estate, as opposed to primary residence real estate. But that’s a secondary part of this discussion.

[12:49] I think we want to, again, reiterate the clarity around the financial decisions are best made to not prepay a home mortgage in any form. And yet there are definitely people whose peace of mind overrides that financial knowledge. And so I can accept that if somebody is just so dead set on having their mortgage paid off or paid down, and that peace of mind overrides any kind of numerical analysis, any kind of financial facts and proof, then okay, fine, you know, you have to accept that the peace of mind is overriding a financial decision, but if we’re just talking finances, we’re just talking numbers, we’re just talking math, then it is most effective to 30 year mortgage fixed if you can, and to be making only regular payments on it.

[13:50] And if an opportunity ever does come up to refinance and potentially lower your rate, that’s of course perfectly acceptable, but typically speaking, you only want to refinance for the debt that is there on that first mortgage and then yeah, go ahead and get a credit line. I understand this person’s desire is to increase their credit line, but I think it’s just so much safer to keep the first mortgage separate from whatever potential credit line may or may not be available based on the values at the time. I think the other aspect that we need to discuss would be the tax implications too. Obviously this is this person’s primary residence and they’re also thinking that they’re able to convert some of their debt into a tax

[14:40] deduction, which is also thinking smart, but I don’t think that most people realize that the tax deductible interest is for the purchase money mortgage only. In other words, if you buy a $200,000 house and you pay cash for it and then decide to take a mortgage out against it, there is a $100,000 cap above the purchase money mortgage. So when you’re purchasing a house, it is under an incentive to borrow as much as possible because you set the bar higher. I recently, the other day actually got to see a 1099 interest statement where computers are now getting sophisticated enough where they showed the interest on the purchase money debt they refinanced and they showed the course, the closing costs, and then they also showed the interest on the

[15:48] home equity that they advanced above and beyond the purchase money mortgage. So this law is nothing new. It’s just with the refinance boom. It’s been almost impossible to enforce, but somehow or another, I think computers are getting sophisticated enough to do it. Yeah, that’s a really good point. And so in this situation, if he did roll everything into the home equity credit line, I don’t know, but that there’s a chance only a hundred thousand of that debt’s interest would be deductible. Do you think that’s accurate? That is accurate. And, you know, that’s, unfortunately, I don’t know how many people that have, you know, bought a $200,000 house, paid $200,000 cash, listened to your books and read your books and said, okay, now I want to go to the bank and take

[16:40] out an 80% mortgage. Well, I mean, you’re walking a fine line in that technically anything over a hundred thousand dollars is not legal, but it has been very difficult to enforce, let’s just put it that way. Right. And as you identified, it’s becoming more enforceable because of the calculations that the computers are able to make. So we need to be towing the line on this and keeping those primary mortgages up as high as possible. And then, yeah, go ahead and do a home equity credit line, but do not, in my opinion, in any way, try to prepay mortgage debt. It’s very, very low cost debt. It’s very, very efficient debt because it’s typically deductible. And even if it isn’t deductible, it’s at such a low cost in today’s

[17:34] world that you’re so much better having that debt and then taking any other dollars that are available and doing something else with them. So if those other dollars are available on a monthly basis, then add that to your cash value of life insurance, add that to your paid up addition writer on your whole life insurance policies, or if it’s more of a lump sum that you have, then you can, for as little as $25,000, get into bridge loan environments that pay 7%. And so you are better off putting your lump sum into bridge loan investments that would then turn around and pay you a monthly income, which you could then use that monthly income to make those mortgage payments with. So then in essence, you have, like in this example, 7% income.

[18:33] Okay, yes, that’s going to be taxed, but that then would be making a 3.5% mortgage payment, which is deductible. So it almost offsets the tax. So you could say you’re taking 7% money income wise and paying 3% expense money debt wise. And obviously that’s a great strategy. If you can take seven to pay off three. So that’s a better approach. Super. Well, Kim, I think it’s been a while since you’ve offered a gift to our listeners. I think now would be a good time to do that. Happy to. We have a fun book that’s called Financial Planning Has Failed, and it even talks a little bit about this mortgage discussion, more from a 15 year versus 30 year scenario, and it’s available only at partners number four, Prosperity.com.

[19:30] There’s an audio version there, and then there’s a print version as well. And again, that’s partners number four, Prosperity.com slash ebook. I think I forgot to say that the first time. Partners for Prosperity.com slash ebook, a special gift for our listeners. And again, there’s an audio version as well as a PDF immediate download. Super. And though we may not have agreed with the logic behind this, we cannot tell you how much we appreciate the questions. Please keep those coming in. Again, this is the No BS Money Guy for the Prosperity podcast. Thank you so much to each and every one of our listeners. And thank you to Kim Butler. Take care all. Thank you for listening to the Prosperity podcast to take control of your

[20:18] money and have it work for you. Visit us at partners for Prosperity.com. If you liked this episode, make sure you subscribe and leave a review.