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Advisors Say Discipline Is Key

By Jim Connolly

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To Using Home Equity

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Financial discipline is the best litmus test baby boomers can use to measure whether a home equity loan is good for them, financial planners say. And, even then, planners have diverse views on whether tapping into the value of a home is a good idea.

Some planners just have a visceral wariness about using a home equity loan.

A home should be “a solid place, a shelter,” says Don Claussen, a financial planner with Financial Pathfinders, LLC, Hendersonville, Tenn.

Claussen says he occasionally receives inquiries from clients but is “philosophically opposed” to the idea. “I hate to see people put their home on the line for any investment that might turn sour.”

But, he notes, there are clients who feel confident they can handle these loans and “it is hard to keep your personal feelings out of the issue because there may not be a good reason you can offer to not go ahead with it.”

For instance, he cites the case of a neighbor who used a home equity loan to buy an investment property in Australia. The purchase worked because the neighbor really wanted the property, and the Australian dollar appreciated against the dollar after the signing, Claussen says.

But, he adds, despite this success, “any time you bet against currency values,” there is another risk in addition to the usual risk associated with a home equity loan.

In general, “my perspective is that any kind of debt is bad,” says George Middleton, a financial advisor with Limoges Investment Management PC, Vancouver, Wash.

So, he says, the preferable option for buying a car or funding an education is to start saving for it.

But, Middleton adds, on occasion, he receives inquiries from clients who usually have paid off or are close to paying off their homes. They need access to cash but do not want to take out a new mortgage, he says. “It is temporary and not a 30-year thing.”

A home equity loan can be easy with no closing costs or points, he says.

Just recently, Middleton says, some clients have used home equity loans to add a bedroom and bath to their home so the children will have a place to stay when they visit with the grandkids, and to pay the down payment on a house for a child.

Other planners say that, when used innovatively, home equity loans can be a tremendous financial tool.

Steven Merkel, a financial planner with Investor Solutions, Coconut Grove, Fla., cites how the use of “piggybacking” a home equity loan enabled him to avoid property mortgage insurance when he recently bought a home.

Merkel explains how home equity worked in his favor. Typically, if you put down less than 20% on a home you have to take out PMI to protect the lending institution if its loan goes bad.

So, Merkel says, if you have a $100,000 mortgage and a $10,000 down payment, you would take out a home equity loan for $10,000. That, he continues, would cover the $20,000 down payment.

By avoiding PMI, which he says gives the buyer nothing, the buyer saves anywhere from $100 to $300 a month which can then be used to pay off interest and principal on the loan.

The strategy works, Merkel cautions, provided a buyer is disciplined enough to make payments that do not just cover interest. Often, he continues, the mortgage lender will offer the buyer the home equity loan. But, he cautions, “for those that are bad at handling debt, this is not a good idea.”

Sherrill St. Germain, a financial planner and principal with New Means Financial Planning, Hollis, N.H., says, “I work with a lot of baby boomers and I am finding that they are making extensive use of home equity loans and, to an even greater extent, home equity lines of credit, a revolving line of credit similar to a credit card.”

They are using both to fund home improvements, pay for college costs and pay down credit card debt at much higher rates, she says.

St. Germain says one client “who had been laid off and found she couldnt get an auto loan used her home equity line of credit to replace a car that died. They also are using home equity lines of credit as back-up emergency funds, so as to avoid having a lot of cash sitting around earning todays ridiculously low interest rates.”

However, she notes, “I would get a little nervous if they used it to pay off credit card debt and didnt get their habits under control.”

But, she says that at least with her clients, she has not seen such problems.

The question has been raised quite a few times during the last 2 years, says Dennis Houlihan, managing director of Houlihan Asset Management LLC, Fort Wayne, Ind.

If a client has the financial discipline, home equity loans can help fund auto purchases and provide a tax benefit at the same time, he continues. Tax deductions can be taken for loans up to $100,000 or $50,000 for a married person filing a separate tax return.

It is good for large ticket items like cars if you dont have cash on hand, Houlihan says. “It is just so cheap right now.”

But for college funding, Houlihan feels there are better ways to get money for school.

Jason Weybrecht, a financial planner and vice president with Spero-Smith Investment Advisers, Inc., Cleveland, says home equity loans are a viable option for some, but used as investments they “dont contribute to peace of mind.”

However, as an emergency reserve to draw upon when needed, they can be a valuable tool, according to Weybrecht.

“We are noticing more clients gain comfort in having the home equity line of credit as their emergency reserve, primarily because short-term interest rates are so low. Why keep 6 months of reserves in cash earning 0.7%, when if you need it you have the home equity line of credit available in an emergency?” he asks.

Reproduced from National Underwriter Life & Health/Financial Services Edition, March 19, 2004. Copyright 2004 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.