Furthering the discussion on whether the credit agencies are using a flawed algorithm to determine our mortgage future, this comment from Dallas bankruptcy attorney Reed Allmand, Allmand Law, deserves its own post. Most homeowners who are underwater on their mortgages got there through home equity loans that Allmand says were used to retire the same type of debt you find on credit cards. And that is what got so very many people into a financial mess. Me, I remember Texas when you could not borrow one dime against your home to protect the homestead:

I disagree with the premise that the Experian algorithm is flawed by classifying a Home Equity Loan as a Consumer Credit Loan. Before the state legislature changed the law to allow Home Equity Loans, the only type of debt that could impair a homestead was a purchase money loan (a traditional mortgage loan), a mechanic’s/materialman’s lien, child support lien, or a IRS tax lien. The argument for allowing home equity loans was to allow consumers to cash out the equity in their property and encumber their homestead with a new debt so they could use the proceeds as they please.

The consumer then uses home equity loan proceeds to make consumer purchases or retire other debt. Unlike a purchase money loan (traditional mortgage) the consumer is not borrowing money to pay off a piece of real estate and build equity in that property. Instead, they are cashing equity in a piece of property to make consumer purchases. This most often is a sign of economic instability in my line of work.

I am a Board Certified Consumer Bankruptcy attorney and I have seen too many clients enter into a home equity loan they should not have. Many times these loans are used to pay off credit card debt. If the consumer had not paid off the credit card they might go into default and possibly be sued but they could not have their home foreclosed on. That is not the case when a home equity loan is used to pay off credit cards, because if the consumer defaults on the home equity loan payments they are subject to foreclosure. I have counseled many clients in this situation and would definitely advise consumers to think twice before getting a home equity loan.

Reed Allmand is a board-certified Dallas bankruptcy attorney and principle at Allmand Law.