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The idiocy of the HELOC (Home Equity Line of Credit)

Zion, IL
By A.B. Dada
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This article is going to infuriate quite a few people I know. I’m not a fan of the HELOC, or what some call the Home ATM. A HELOC, or the Home Equity Line Of Credit, allows you to take a loan out against the equity you’ve built in your home. HELOCs have been very popular even without equity built through paying down a loan, just due to the Federal-Reserve created inflationary pressures that have caused housing prices to rise — giving people more equity in a home than they actually earned by paying their mortgages. Of course, many of these equity values are now falling, leaving some people with mortgages and secondary loans (HELOCs) that are valued over the current value of the home.

First of all, I do believe the HELOC can be useful for a few things: investing in a new business, paying down high interest debt permanently, and emergencies (health or other). HELOCs are terrible ideas for those who want to use the money to buy a new car, take a vacation, or spend on frivolous and unnecessary consumer goods. Let’s look at why that is.

I’ll make an example on an “average” $300,000 home. Let’s say you put down 20% (which is unheard of lately), so you need a mortgage of $240,000. At 6%, your mortgage payment will be $1439 per month. If you pay that amount each month, your mortgage payoff amount after one year is $237,052. So for the first year of payments totalling $17,268, you’ve added a whopping $2948 in equity for the year. Don’t forget to add taxes and maintenance to that $17,268 figure to see how much equity you get back in the first year of ownership.

After year two, your payoff amount is now $233,923. Two years of payments is $34,536, for an amazing return in equity of $6,077.

Year three brings a payoff amount of $230,601. Year four is $227,074. Year five is $223,330.

After five years, you’ve paid $86,340 in mortgage payments, and have $16,670 in equity you now own in the house, not including the $60,000 down payment you made.

Let’s say you want to take a vacation, and it happens to be $16,670 exactly. You take a home equity loan out (HELOC) for that amount, and pay it back at 7% interest. Or maybe it’s a new car, or a new home entertainment system. Whatever it is, you’ve spent that equity.

What has it cost you to take a vacation? Surely not $16,670. No, that vacation cost you $86,340, because that is what it cost you to get that equity level in your home. In addition to that cost, you purchased a depreciating asset (TV or car) or short term entertainment (a vacation) with no long term asset value. Either way, you surely don’t have anything worth $16,670 left to show for the HELOC you received. Even worse, you’re now paying the HELOC off in addition to your $1439 monthly mortgage that you have left for 25 years. If your HELOC is a 10 year loan, at 7%, your new monthly payment is $194 per month, which over 10 years is a payment total of $23,226. At the end of 10 years, you basically have returned that equity (and paid down your home loan), and you may or may not still have the asset you bought or memories of the vacation you took.

So for the asset or vacation you received worth $16,670 at the time, you paid $86,340 + $23,226 or $109,556 to get it. Does it sound worthwhile to waste your time, energy and future years of your life to pay $109,556 for an asset maybe worth $3000 after just a few years?