With consumer debt at an all-time high, San Diego-based Institute of Consumer Financial Education (ICFE) has joined the growing chorus of experts warning consumers about squandering equity.

Too often, consumers with high credit card and other debts turn to their fast-growing equity as an easy way out, says the San Diego based nonprofit group dedicated to helping consumers improve their spending habits, increase savings and use credit more wisely.

"Because revolving credit card debt accumulates on a daily basis, many consumers find themselves feeling hopeless, fearing they will never get their debts down to a manageable amount, thereby always finding themselves on the money-merry-go-round," says Paul Richard, the institute's executive director.

An equity loan, or second mortgage allows you to borrow money against your home's equity -- that portion of your home's value that isn't otherwise encumbered by a mortgage. When you buy a home with a down payment of say 20 percent, you have a 20 percent equity stake in your home. Over time, mortgage payments and appreciation can give you a larger equity stake. Likewise, depreciation can reduce your stake.

Lenders prefer that you have outstanding home loans that are equal to no more than 80 percent of the value of your home, but for homeowners with a long-time and top-notch credit standing and payment history, it is not difficult to obtain loans that equal as much as 125 percent or more of the value of your home.

Responsible equity use can be a wise decision, says Richard.

Equity loan interest rates are almost always cheaper than bank card and retail card credit and that will save you money when you use equity loans to pay off or consolidate more expensive debt. With the lower interest rate and flexible terms, equity loans also come with what's likely a lower monthly payment than the combined monthly payments of all the debts you consolidate.

Also, because an equity loan is secured by real estate, the interest and some related costs are tax-deductible -- provided your total mortgage debt does not exceed 100 percent of the value of your primary residence.

However, any loan tied to your home's equity is by nature an equity-depleting loan and you don't have an unlimited amount of equity to bank on.

The best way to bank on your home is with equity loans used for capital improvements and investments that provide an equal or better return on your money than the cost of the loan. Certain home improvements, education for the kids and new business financing are relatively better uses of equity than buying cars and boats, debt consolidation and vacations.

Some experts advise never using your equity, but to pay off your mortgage by retirement time so you can live "rent" free when your income is reduced and fixed.

The exception may be for emergencies and unforeseen events that might reduce your income or place added demands on your wages -- job loss, births, illness, injury, death and others.

Also, during hard economic times, an equity line of credit, obtained but not used unless you become unemployed for an extended period, can help you sleep at night if you have nightmares about a job loss or a wage cut.

Dangers of equity use

However, faced with a house full of cash, too many home owners over-estimate their ability to make the payments on a loan that holds the roof over their heads as collateral.

"The biggest danger to home equity loans is homeowners gamble their house they won't ever have a problem making the payments. At least with credit card debt, no matter how deep in debt you may be, no matter how unable you may be to pay the bills, they can never (sic) take your house," said Richard.

Richard also says home owners who use equity to pay off bank card and retail card debt who never close out the accounts can be tempted to run up the credit card debt again and become financially over-extended.

"Then you will have more credit card debts and your obligation to pay off the home equity loan. If you have learned your lesson about credit cards and take out a home equity loan, then close out all the credit card accounts because you are betting your home on it," Richard said.

He also says don't overlook the term of equity loans. While the payments are reduced the loan commitment calls for terms of 10 to 30 years, depending upon the type of equity loan you land.

"The last big negative to taking out a home equity loan is that it strips you of any flexibility you may have should you decide to sell your house. This is especially true if it's one of the home equity loans that exceeds the actual value of the home. In order to sell a home, all debts on the house have to be cleared, including first and second mortgages and home equity loans. If you owe more on your house than it's worth, you may have to make up the difference to sell it. And chances are, if you are in this predicament in the first place, you won't have that kind of money lying around," Richard says.

Published: November 15, 2002

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Broderick Perkins parlayed a career in old-school journalism into a contemporary digital news service that really hits home. The award-winning consumer journalist, originally from Wilmington, DE, is founder, publisher and executive editor of the bootstrap DeadlineNews Group, a Silicon Valley-based editorial content and consulting service specializing in residential real estate, consumer news and related editorial consulting services. The DeadlineNews Group includes the website, DeadlineNews.com, offering real estate editorial content and consulting services, and its back shop, the Deadline Newsroom, an open house on news that really hits home. Perkins obtained his formal journalism education from University of Delaware and a journalism boot camp, the Institute of Journalism Education at the University of California-Berkeley. He went on to 20 years of service as a daily newspaper journalist at the Wilmington, DE News Journal and San Jose, CA Mercury News. Perkins covered housing on the San Jose Mercury News reporting team which earned a General News Reporting Pulitzer Prize in 1989 for coverage of the Loma Prieta earthquake. He has also produced real estate, consumer and small business content for the Wall Street Journal, Los Angeles Times, RealtyTimes.com, Nolo.com, Better Homes and Gardens, the National Association of Realtors, Homestore/Move and Intuit/Quicken among more than three dozen publications. In addition to managing the DeadlineNews Group, Perkins most recently served as chief editorial consultant for Nolo's Essential Guide To Buying Your First Home, Nolo, and writes real estate television scripts for RealtyTimes.com.