Q&A of the Day – Should You Use a Home Equity Loan to Payoff Higher Interest Debt?
Each day I feature a listener question sent by one of these methods.
Email: brianmudd@iheartmedia.com
Social: @brianmuddradio
iHeartRadio: Use the Talkback feature – the microphone button on our station’s page in the iHeart app.
Today’s Entry: Brian, I’m a long-time listener who has always enjoyed your insight on financial matters. Though I know you don’t cover financial matters as often as you once did, I was wondering if you would address a question that’s been on my mind. I frequently hear advertisements talking about what a “no-brainer” it is for homeowners to take out a home equity loan to pay off higher interest debt. But is it really? That’s my question for you. Thank you, I’ll be listening.
Bottom Line: You’ve got it. You had me at financial analysis and while I’m at it I’ll address the reason I don’t provide nearly as much financial/investment related analysis as I once did. I do occasionally get asked that question as well. I have a background in business and financial analytics that iHeart (then Clear Channel) decided to tap into at the onset of the Great Recession before we knew the extent of what would become known as part of the Great Recession. From March of 2008, through 2011, I was repositioned by senior management as a financial analyst and thus focused most of my content and analysis during that close to three-year period through that perspective. With that said, I’m every bit as passionate about financial analytics as I’ve ever been and my favorite thing to do still is to provide information that’s “helpful, useful and repeatable” which has always been my mission statement. On that note let’s dive into your question.
I’ll start by offering this up. Getting a home equity line of credit to pay off higher interest debt can be a “no-brainer” but no, it’s not always a no-brainer, and Florida is a somewhat unique standout in this conversation. That’s due to Florida having the strongest homestead protections in the country. Ubiquitous financial advice usually isn’t the best advice and this conversation falls into that category. Here are situations where tapping into one’s home equity to pay off higher interest debt would or could be a “no-brainer” for Floridians:
- If the property is a non-homestead property (second home/vacation property, rental, etc.)
- If one has the funds to pay off the loan and is choosing to use the line of credit as part of a broader strategic investment strategy
- If one has visibility as to when they will have the funds that would be sufficient to pay off the loan if needed
That sets the stage for circumstances in which a home equity line of credit for the purpose of paying off higher interest loans isn’t a “no-brainer” and may be a bad financial strategy:
- If the property is one’s primary/homesteaded property in Florida
- If the property doesn’t have an existing property insurance policy in place
- If you don’t have access to the funds needed to pay off the home equity line of credit if needed
I’ll boil this down momentarily through all of those scenarios. The over-arching theme is this. Trading a secured line of credit in the place of an unsecured line of credit is an important decision that should be considered by each individual given their own set of economic circumstances. If you have a secured line of credit taken out and you default you have something to lose. If you have an unsecured line of credit taken out and you default you may have something to lose (other than your credit score and credit worthiness), this is an important distinction. This is where Florida’s best-in-the nation homestead law comes into play.
Under Florida law your homesteaded property is protected under most circumstances, even under bankruptcy protection, provided that you remain current on all your homesteaded properties obligations (mortgage if you have one, taxes, dues/assessments if any exist). Specifically:
- In bankruptcy, the Florida homestead exemption allows a primary residence of unlimited value to be protected from creditors as long as the debtor has lived in Florida for 40 months or more, and the property is not larger than half an acre in a municipality or 160 acres elsewhere.
If that is one’s situation, I’d not consider taking out a home equity line of credit to pay higher interest debt unless it meets the exceptions I’ve already outlined. A lot of things can go wrong in your financial life but provided you’re able to retain your home, and all of your home’s equity (which most Floridian homeowners have a considerable amount of), it’s possible to quickly recover on the other side of the financial adversity. If however, you lose your home as part of that financial adversity, that can be a very different story.
The other important dynamic Floridians specifically need to consider is this. If your property (whether your primary, second home, investment property, etc.) is paid off and you’re not paying for property and/or flood insurance, that must be considered too. While anyone “self-insuring” should have funds set aside or at least accessible to pay for property repair and damage, what often can be and is discounted by those who haven’t carried property and flood insurance in a while is the cost of it these days. Any line of credit taken out on a property will obligate the owner to pay for the level of property and flood insurance demanded by the lender.
The average cost of a property insurance policy in Florida is currently $4,419. The average current cost of a flood insurance policy in Florida is $699. That’s over $5,000 of annual expense that is added and must be taken into account for owners in this situation. Based upon the specifics of one’s situation, it’s possible that the additional expense of accounting for those policies could completely mitigate the potential financial benefit of interest savings by paying off higher interest debt while also putting the property securing the loan at risk if defaulted on.
Hopefully that’s helpful, useful and repeatable...