Home equity loans good for big goals, but not for casual cash
For many years, banks and savings-and-loans - and their customers - gained financial strength through home ownership. The banks made profits by lending money to build or buy homes, and the public acquired real estate, one of the most important keys to financial security. Now, because of tax reform, these banks, S&Ls, brokerages, and finance companies are heavily pushing a product that could take away that key from some homeowners.Skip to next paragraph
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Tax reform did not create the home equity loan, but by keeping the interest deduction for first and second mortgages while taking away the deduction for other consumer debt, Congress opened up the home equity loan to many good uses - and the possibility of many abuses.
``Home equity loans are good for people who want to use them for the right thing,'' says Paul R. McLaughlin, an accountant and financial adviser in Braintree, Mass. ``But the person who owes money to MasterCard, Visa, American Express, or whatever and uses these loans to consolidate bills is running a great risk.
``If you run into hard times and you can't pay your American Express or Visa, the chances of their coming after you and taking your house are slim to none. But if you consolidate them with a home equity loan [and then run into credit trouble], the chances of keeping the house are slim to none.''
This may be an overstatement, but it is a key to the debate over what could turn out to be the most controversial product to be pushed by the banks since banking deregulation. Americans have some $3 trillion in equity locked up in their homes, and lenders are working overtime to see how they can get a piece of it.
What some are calling a loophole in the tax law preserves the interest deduction on home loans and on home equity loans, or second mortgages, as long as the total debt does not exceed the purchase price, plus the cost of any improvements.
Let's say you bought a house a few years ago for $100,000, making a 20 percent down payment. Since then, you've put $15,000 worth of improvements in the place. The equity you can tap for any purpose is $35,000: the down payment plus improvements. Most banks will lend you up to 75 or 80 percent of that amount, or $26,250 to $28,000.
You can raise the base above $35,000 if the money is used for educational or medical expenses. So if the value of this home has appreciated to $130,000, you could borrow up to 80 percent of that higher figure for school or medical costs.
While there are dangers, these loans have several advantages. They give you quick access to a large pool of money at reasonable rates, more flexibility in repaying the loan, and a tax deduction.
Before considering a home equity loan, however, think about how you're going to use the money. It should be reserved for important goals, like home improvements, retiring expensive debt, your children's - or your own - education, or starting a business. It should not be considered a pool of money that's ``handy'' for whatever comes along.