'Equity loans' on your house may be handy -- or harmful
There was a time, not too many years ago, when a home was simply a place to live. Those unimaginative days are quickly slipping away. For several years the home has also been an investment; keep it a few years, spend some money to fix it up, and it will help pay for another home.
Now, to some banks and brokerage firms, a customer's home is a way to lend that person some money, add to their long-term customer base, and make a nice profit. Brokerages like Merrill Lynch & Co. and Shearson/American Express have designed ways to let people use part of the equity in their homes as a running line of credit. Or perhaps the bank that holds your home mortgage has invited you to take out one of these loans. The Bank of New England, for one, has been sending letters to its customers this month, saying its ''Equity Reserve could be the last loan you'll ever need.''
These financial devices, called ''equity loans,'' can be a source of additional income for special expenses like college tuition, a new car, or a vacation. But they can also be a source of financial danger that could result in the loss of the home if not used carefully. A person contemplating an equity loan should be fairly certain about his current financial situation, borrowing and spending habits, and future earning potential.
''Equity'' is defined as the current appraised value of a home, minus any unpaid mortgage balance. So if your home is worth $100,000 and you still owe the bank $40,000, your equity is $60,000. The brokerages and banks are offering to lend customers 70 to 75 percent of this amount.
In some ways, equity loans are quite similar to second mortgages, but in some of the most important ways they are quite different. When you take out a second mortgage, a responsible banker or finance company representative will - or should - ask you what it is for (in Texas, a law specifies how second mortgages can be used), and will examine your financial situation to see if you can handle the additional payments.
When you get the money from a second mortgage, the interest rate is fixed through the term, or time, of the loan. The loan is repaid in equal monthly installments which include principal and interest. So like a car loan or first mortgage, the loan is paid off at the end of the term.
But with an equity loan, many of these precautions are absent. The literature on them often tells customers they can use the money for anything they want except, in the case of brokerages, to buy stocks and other securities. There is no loan officer to see if you can handle the payments or look for other types of financing. Most of the programs have a ''floating'' interest rate - about two percentage points above the prime rate - which can change your payments as often as every month. And some allow you to make payments only to interest, paying principal in a few years.
The equity loan was actually started by a number of small and medium-size banks and some large finance companies as a special financial planning tool for certain customers. But now, financial giants like Merrill Lynch and Shearson/American Express have put their marketing clout and financial resources behind it.
Equity loans are not available everywhere; in fact, only 15 states permit one or both of the Merrill Lynch or Shearson/Amex programs. They are Alabama, Arizona, California, Connecticut, Georgia, Hawaii, Illinois, Massachusetts, Nevada, North Carolina, Oregon, Pennsylvania, Virginia, Washington, and Wisconsin.
Merrill Lynch's program is called the ''Equity Access Credit Account.'' While the minimum line of credit is $10,000, there is no maximum. The credit line can go up to 70 percent of a home's equity. You can get to the money with special checks or a Visa card. The annual percentage rate floats daily at two points above the prime - currently 101/2 percent.
While this may seem like a reasonable rate, Merrill, like its competitors, imposes other charges when the account is opened. At Merrill, there is a one-time fee of 2 percent of the entire line of credit to cover paper work and appraisal of your property. On that home with $60,000 of equity, the line of credit could go to $42,000, giving you a fee of $840. This must be paid whether or not the entire line of credit is used. The company also has an annual maintenance fee of $35. Both of these charges are taken out of the line of credit, so there are no out-of-pocket expenses to open the account.
You do not have to be a regular Merrill Lynch customer to open an Equity Access account, but that is not so at Shearson/Amex. To qualify for its ''Key Client Credit Account,'' you must have the equivalent of $20,000 in a Shearson brokerage account. Clearly, Shearson is aiming at a higher-income group of people, which may be why its product is accepted in 12 states, while Merrill Lynch's is in eight.
In most cases, the credit limit at Shearson equals 75 percent of a home's equity. But if the equity is more than $300,000, you can only borrow 50 percent of the figure above that amount. The maximum line of credit is $750,000; the minimum $40,000. The interest rate floats at 11/2 percent above prime, but there is also a $250 application fee and a one-time origination and a one-time service fee of 21/2 percent of the credit line when the account is opened.
Instead of a check or credit card, money in the Shearson account can be wired to your bank with a toll-free phone call.
The plans offered by banks also have fees, service charges, and minimum and maximum amounts that can be borrowed. Unlike brokerage products, money from these can legally be used to invest in stocks and bonds or mutual funds.
With all of these plans, remember, you are putting your home up as collateral. Because they are fairly new, there is no record of foreclosures, but the possibility is there. And if interest rates shoot up again but your income does not, the monthly payments could suddenly become unaffordable.
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