House-Rich, Savings-Poor — Using home equity to pay for everyday purchases? You may be one of millions of Americans who are part of a dangerous new trend. Here’s how to get your house back in order.

By Linda Fjeld | Illustrations by Joe Kovach

You’ve heard it a thousand times: A home is the best investment you’ll ever make. It’s as true—maybe even truer—today than ever before. But for too many Americans, a home has become just another ATM, one that they’re visiting dangerously often. These homeowners are using home equity to finance lifestyles beyond their means—from expensive vacations to those daily $4 lattés that quickly add up—giving “home sweet home” a dangerous new meaning.

Two factors have made it awfully tempting to misuse that home equity line of credit checkbook: low interest rates and rapid residential real-estate appreciation.

“Over the past couple of years we’ve seen the lowest interest rates on home mortgages in more than four decades,” says Roger Kapsner, vice president of consumer lending at Thrivent Financial Bank. “That’s leading people to think they have free money to spend on frivolous items. But it’s not free, and spending home equity on unwise purchases can lead to problems later.”

What’s more, data compiled by the Office of Federal Housing Enterprise Oversight (OFHEO), the agency that tracks home prices around the country, reveals that the market value of the average home jumped by nearly 13 percent nationwide from the third quarter of 2003 to the same period in 2004. That jump exceeds all annual increases during the past 25 years, according to the study.

“Over the past 18 to 24 months, these factors set the stage for many homeowners to buy as much house as they could afford and to readily tap their equity for various reasons—some smart, some not so smart,” Kapsner says.

U.S. Department of Commerce data supports Kapsner’s perspective, reporting new mortgage originations at $3.9 trillion in 2003—nearly half of the total $8 trillion in the nation’s current outstanding mortgage debt. In other words: There’s a lot of money that has been invested in new mortgages recently. According to the American Bankers Association, the average home equity line of credit increased 44 percent from 2003 to 2004.

Of course, there’s nothing wrong with taking out a right-sized mortgage and home equity line of credit. It remains, for most consumers, a smart financial move. Using your home equity to reinvest in your home through strategic remodels and additions can pay healthy dividends. And in many cases, consolidation of outstanding loans may make sense.

The house-rich, savings-poor trap lies in the degree to which some consumers overextend themselves, as well as the reasons they do so. Some take on exceedingly large mortgages to buy houses they may not be able to afford long-term. Some take out home equity loans to finance high-interest consumer spending sprees.

“Most people are buying homes at the top of their range—and committing to mortgages based on two incomes,” Kapsner says. “The important thing for people to understand is that they are putting their biggest asset on the line. They must be comfortable with the risk they are taking.”

Savings Drought
So what is at risk? Well, with the rush toward more and bigger mortgages, something has to give. Unfortunately, that “something” has been savings and investments. With so many demands on consumers’ paychecks, stashing cash for the future has fallen to the bottom of many priority lists.

Retirement Confidence Survey data released by the Employee Benefit Research Institute shows that 45 percent of all workers reported total household assets, excluding the value of their home, of less than $25,000 in 2004. What’s more, a recent national Thrivent Financial survey of non- retired adults shows that only 67 percent said they are currently saving money in a 401(k) or other investment program.

Does all of this sound eerily familiar? With mortgage and other debt looming, how can you tip the scales back in your favor for a secure future?

“Tapping into your home equity to pay your monthly bills is not the answer,” says Phil Eldredge, national sales desk manager for investments and advice at Thrivent Financial for Lutherans. Instead, it’s critical to reduce the money you’re using to finance consumer debt, and put it to work for you in long-term investment vehicles.

To get your priorities in order, including putting yourself back in position to use your home equity strategically, Eldredge offers five steps to escape the house-rich, savings-poor trap:

• “Keep track of expenses.” Eldredge suggests keeping a spending record for one month to get a better handle on your cash flow. By doing so, you can see where you can cut back and use those dollars to fund your savings goals.
  
• “Establish realistic goals to reduce debt.” Make a list of all of your credit cards, with interest rates, outstanding balances and minimum payments. Start with a clear plan to pay down the debt. Once a credit card is paid off, eliminate it. Then carry only one card, so you’ll be able to keep better track of your spending and make sure you can pay the balance each month. Eldredge also recommends rewarding yourself with something small—a special meal, perhaps—when goals are reached, so you won’t get discouraged and abandon your plan.
  
• “Don’t misuse your home equity and exhaust it.” It’s reassuring to have a home equity loan or line of credit available. It can be a great way to reinvest in your home. In some cases, it may make sense to consolidate revolving debt with a home equity loan, since it may lower your monthly outlay of cash and provide a tax deduction. But if you’ve been using home equity to pay for daily living expenses, it’s time to stop.
  
• “Consolidate your credit cards into one low-rate card for emergencies.”
  
• “Start a periodic savings plan.” An emergency fund will help you avoid relying on credit if you face an unexpected health event or job loss. Build investing into your budget, just like other “non-optional” bills. Eldredge recommends making periodic payments to your company’s 401(k) and an IRA a priority.

Eldredge offers another creative tip for reducing consumer debt: “As your balance drops, so does your minimum payment. Instead of paying the minimum each month, budget for—and continue to pay—the highest amount that you can afford on a monthly basis. You’ll be surprised how much faster the debt will be retired,” he says.

Once you start to make progress toward your debt-reduction goals and your savings start to grow, you’ll start to feel better about that roof over your head, and the scales will again tip in your favor. “Remember,” adds Eldredge, “it takes some discipline, but over time you’ll be amazed at what you can accomplish.”

Financial services writer Linda Fjeld lives in Minneapolis.

Fast Fact:
The market value of the average home jumped by nearly 13 percent from 2003 to 2004.
Source: Office of Federal Housing Enterprise Oversight

Fast Fact:
Just 67 percent of non-retired adults say they are saving for retirement.
Source: Thrivent Financial for Lutherans survey

Fast Fact:
Americans owed $766.2 billion in home equity loans in 2004, twice what they did in 1998.
Source: U.S. Federal Reserve

“[Low interest rates are] leading people to think they have free money to spend on frivolous items. But it’s not free, and spending home equity on unwise purchases can lead to problems later on.”
—Roger Kapsner, vice president of consumer lending at Thrivent Financial Bank

Balance Found

Vickey Zajac, 34, a Thrivent Financial for Lutherans member in Hebron, Indiana, admits with a smile, “I was attracted first to my husband, Jim—then to his house.” When the Zajacs got married in 2001, their love for that same house led them to seek financial help from Carsten Falkenberg, a senior financial consultant with Thrivent Financial in Crown Point, Indiana.

Unfortunately, the Zajacs’ dream home came with two mortgage payments each month to go along with some mounting credit card debt. “The debt was overwhelming when we were first married, but Carsten helped us create a plan for reaching our goals,” says Vickey.

Falkenberg adds, “I took them through the steps that it would take to get them on track financially, then Vickey and Jim did the hard work.”

The Zajacs gave up “little things,” as they put it. “When Carsten helped us analyze our cash flow, we couldn’t believe how much money we were spending unnecessarily,” Vickey says. By limiting their trips to the coffee shop and buying fewer clothes, they were able to put extra cash toward their credit card debt. In fact, now they’ve completely eliminated that item from their monthly budget. The result: The Zajacs now focus on chipping away at their mortgages, using a larger share of their income to build equity and less to finance high-interest debt.

“We paid off a huge amount of debt in two years,” Vickey reports happily. Lifting that financial burden is especially important now that their son, Michael, has entered their lives.

“Make savings a priority by paying yourself first,” Vickey says. “It sounds cliché, but it really works if you’re serious about reaching your goals. Carsten’s advice has changed our lives.” —L.F.

Right at home and back on track: Jim, Vickey and Michael Zajac.