financialcounselor

The Hangover from Excessive Borrowing

In Lesson of the Day on March 30, 2012 at 11:46 pm
The Hangover

The Hangover (Photo credit: Wikipedia)



One of the easiest financial mistakes a person can make is borrowing more money than they need. I see it all the time. The effect of borrowing more money than you need is like a hangover. You drink way too much, and then you wake up in a fog with a jackhammer in your head and a monkeywrench in your stomach. You borrow way too much, and it’s the same thing, only the monkeywrench is in your budget, and the jackhammer is those monthly payments. At least with the hangover from drinking, things are back to normal after a day.
This is what happened to two of my clients, Janet and Bob from New Mexico. Their debt hangover was as bad as what you’d get after a raging New Year’s Eve party hosted by Rick James.
Bob and Janet’s big borrowing hangover was the result of a bad decision about an equity loan. This couple had planned to take out an equity loan in order to consolidate their credit card debts and car loan. Pay it all back with a single payment and a low interest rate. Nice and simple, right? Well, what happened was this: As they were putting together the mortgage contract with their broker, he asked them multiple times if there wasn’t some other expense they had, or some need that could also be paid for using the additional equity in their home.
“First he asked if we didn’t have other debts, then he asked if we wanted to borrow extra to take a vacation,” Janet said.
The clincher came when the broker asked them if there weren’t some home repairs or maintenance that needed to be done. Janet and Bob had been talking about remodeling their kitchen, and they decided right there in the mortgage broker’s office that they would do it, adding the cost of the construction job right into the equity loan. Now that’s a good salesman, keep throwing that line in the water, and eventually something will nibble on your bait.
“We went in to borrow twelve thousand dollars and we ended up taking out twenty-five grand,” she cried.
“Then what happened?” I asked. “The payment was just more than you planned for?”
“It ended up costing more to redo the kitchen then we thought,” Janet said. “So on top of the loan payment which is way more than we planned for, we owe the contractor money, and we’re paying him.”
Because they let the broker talk them into accessing all the equity in their house, their original plan for a $12,000 loan with a payment of $200 was now costing them $500 per month, with what they were paying the contractor. And they’d had to pull money from their savings to ensure the remodeling job got finished.
“Hey, at least you’ve got a nice, new kitchen,” I said, trying to look at the bright side. “That’s something.”
“I don’t even like going into that kitchen, knowing what it’s costing us,” Janet said.

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