Your Home Is Not A Cash Machine!

Booming house prices have encouraged many people to borrow against their homes. Alas, this strategy can backfire spectacularly.

In financial jargon, there is no shortage of TLAs (three-letter acronyms) -- which, fittingly, is itself a TLA. For example, you have APR (annual percentage rate), CGT (capital gains tax), PPI (the dreaded payment protection insurance), TAR (total amount repayable) and many more. You'll find more money language in my Jargon Buster and Devil's Dictionary Of Money.

One TLA which gives me cause for concern is MEW, or mortgage equity withdrawal. MEW happens when homeowners borrow against their home but don't reinvest the proceeds into property. This reduces their equity (the value of their homes less any outstanding mortgages) but releases funds to spend or invest elsewhere.

When house prices are rising, as they have for the last decade, they create a 'wealth effect' which encourages homeowners to spend more and save less. Indeed, some homeowners mistakenly see their properties as cash machines from which they can withdraw money to subsidise their lifestyles.

Of course, a mortgage is one of the cheapest ways to borrow money, because it's secured against your home and is therefore safer (from the banks' perspective) than credit cards or unsecured personal loans. However, by increasing your mortgage or taking out a second mortgage or secured loan, you put your house on the line. In the words of the official caution: "Your home is at risk if you do not keep up repayments on a mortgage or other loan secured on it."

Let's take a look at our MEWing record:

Mortgage equity withdrawal from 1990 to 2006

As you can see, MEW is very much a creature of housing booms: it peaked in 1990 before tumbling rapidly as the last house-price crash took hold. Indeed, between 1992 and 1998, the overall MEW figure was negative, because British homeowners actually repaid £5.5 billion more mortgage debt than they MEWed. However, as the housing market recovery began to gather pace, MEW started to surge once again, hitting an all-time peak of over £57 billion in 2003.

One reason why MEW has been so strong in recent years is that homeowners borrow against their homes to repay more expensive unsecured debts by rolling them up ('consolidating') into a cheaper loan secured against their homes. Although this can be a good idea in principle, it often fails in practice, as these debts are repaid over a much longer period (up to 25 years), which produces a larger interest bill overall.

In effect, the majority of MEWers are using their housing wealth to support unsustainable lifestyles. In the US, where MEWing is practically a way of life, it is referred to as "selling furniture to pay the laundry bill"!

Alas, MEWing is not a universal cure-all for overspending. For many people, it is part of the problem, rather than the solution. Too much MEWing, coupled with overspending, could lead you to fritter away your home, as I explained here and here. Having witnessed many people lose their homes in exactly this way in the last housing crash, I fully expect even worse outcomes next time around. I'll be blunt: think twice before MEWing to pay off existing debts, because this can backfire painfully.

To get to grips your debts, read Ten Ways To Dump Your Debts and visit our Get Out of Debt centre and Dealing with Debt discussion board.

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