Your house is not an ATM.

There has been a lot of noise lately about lenders “freezing” HELOCs across the country. For those of you that don’t know what a HELOC is here is a quick breakdown.

A HELOC, or Home Equity Line of Credit is a revolving credit line that uses the equity of your house to secure the debt. So, if you have a home that is valued at $500,000 and you’re first mortgage is for $300,000 you have approximately $200,000 in equity. That means, that you could get a $100,000 HELOC and still maintain an 80% Loan to Value ratio on your home.

By getting a HELOC, you now have access to borrow against the equity in your home. You can borrow some money, pay it back, then borrow again. Depending on what the money is used for, you may be able to deduct the interest paid against this loan on your taxes.

So, if the bank is willing to give you a loan on your house, why shouldn’t you use it? Because your house is not an ATM.

If you haven’t read my post titled Who owns you? you might want to read through that first. By borrowing against your home and paying interest to the bank you are simply paying a whole lot more for the things that you are buying. If you aren’t getting paid to borrow money, it is bad debt.

Using your home equity to upgrade your home prior to a sale may not be a bad idea, if you are able to add more value to your home than the cost of the upgrade plus the interest you paid. If you can’t do that, then just be patient and save up the cash to make the purchase yourself. If you can afford paying a few hundred dollars a month to pay back the bank, you can afford a few hundred dollars a month to pay yourself.

Saving money to make a purchase in the future is a great exercise in financial restraint, and in patience. Generally speaking, we don’t need everything today, we want it. There is a huge difference between the two things.

Please, if you have a HELOC today, use it responsibly. A HELOC can be a great safety net if you come up on severe financial stress, but should not be viewed as free money. You should only use this money to generate cash or as a last resort.

So, back to the HELOC locking nonsense. I’m not a fan of it at all.

Now, I understand what lenders are trying to do. They are effectively looking through their models, looking for unnecessary risk and trying to remove it. Most of the HELOC contracts specify that the lender can freeze the line of credit, however the reasons why vary greatly. It is my opinion that the lenders are trying to act in there best interest, but they are being a little short sighted; in fact this may even turn into an ugly legal battle.

As I said before, a HELOC can be a great safety net for families. While I firmly believe that you should pay yourself first, save money for a rainy day and all of that stuff; when things really hit the fan a HELOC might provide that extra cushion that you need. By abruptly freezing a HELOC, the bank is effectively taking cash from your pocket.

Let me clarify that statement. You must of course pay interest on money borrowed from a HELOC, so the cash is not free. The problem is, that with the threat of HELOC freezing, people tend not to pay additional principal against the loan. Instead of trying to pay down the balance as soon as possible - thereby reducing interest payments - I know a lot of folks that are putting that extra principal payment in a lower yielding savings account.

People are scared that if they put all of there cash against the HELOC to reduce the interest burden, if they need that money it now won’t be available. The net result of this is that you pay more interest that you need to.

It really is an ugly catch-22 as the two parities are in a sticky situation across the board. With the current state of the real-estate markets and the sharp increase in defaults banks are trying to shore up there balance sheets; at the same time, they are potentially hurting some of there best customers personal balance sheets or financial flexibility.

If you’re HELOC has been locked, or you’ve changed how you pay as a result of this threat I’d love to hear from you.