Count the costs

"Doom and gloom" reports of the U.S. housing crisis are unavoidable these days. My own economic perspective is that the present housing price correction was not only inevitable, but, from the vantage point of many soon-to-be first-time homebuyers, is very welcome news. The present housing situation and its cousin, mortgage financing, have provided the catalyst for an important discussion for believers: What should our home mortgage borrowing look like?

The most common occurrence in the last five years was for homeowners who had built up a great deal of equity to extract money from their homes by either doing a "cash out refinance" or by opening a Home Equity Line of Credit (HELOC). A "cash out refinance" involves replacing your current mortgage with a brand new mortgage, usually at a lower rate (a good thing), and at a higher dollar amount (not usually a good thing). The difference between the new mortgage amount and the old mortgage amount represents the amount that was "cashed out."

A HELOC involves setting up a credit line that is secured by the home. In this option, principal is not amortized, meaning that as long as interest-only payments are made, the amount borrowed can remain outstanding indefinitely. Principal can be paid back in a HELOC as slowly or quickly as the borrower desires, giving good flexibility to the homeowner in his cash flow.

It would be difficult even to attempt to write an article condoning most of what has taken place in American society over the last five years as it pertains to both of these options. By and large, Americans have treated their houses like ATM machines, and the result has been to force monthly payments into unaffordable territory, and in many cases, to borrow more money out of the house than it is now worth. With that said, it is important that believers not oversimplify discussions such as these. The following three principles ought to serve as general guidelines:

1. A Home Equity Line of Credit ought to be used only to replace present debt, not create new debt. Because HELOCs are often at lower interest rates than various credit card or auto finance rates, and because of the tax advantages of mortgage financing, it is possible that paying off other bills with home borrowing would be prudent. The very important consideration will be that you pay a principal and interest payment sufficient to retire the debt in a timely manner. Too often, homeowners have paid off other bills with their HELOC borrowing, only to let the reduced monthly payment justify an increase in other spending.

2. I do not believe it is ever prudent to let your "debt-to-value" ratio (i.e., the amount you owe relative to the value of the home) exceed 80 percent. To allow your equity in the home to go lower than this opens up the door to frightening possibilities. If your mortgage balance is 50 percent of the market value of your home, and you want to refinance some debt, analyze the situation. If borrowing will leave you with ratios worse than I have suggested, I strongly discourage you from proceeding.

3. While many people condone the idea of using equity in a home for re-modeling expenses that potentially add value to the home, please proceed cautiously. Will the increased debt create a new monthly payment that is outside of your means? Are the things you want to do to your home really adding resale value, or are they just "preferential" items that a homebuyer may not be willing to pay more for? Using home equity for upgrades should only be done if your savings and income are insufficient to do so, and if you have judiciously analyzed the pros and cons in the light of your overall financial picture.

Overall, the principle of always seeking to pay down debt, and not add to it, should be your guideline. To the extent that home borrowing can facilitate this goal, do not rule it out. But those cases are the exception, and not the rule. Count the cost before proceeding (Luke 14:28).