Borrowing on home equity: it's good if you don't raise the roof

Home is where the heart is. It is also where Americans are finding billions of dollars of borrowing power. With many Americans simply leveraged-out on their mortgages, auto loans, and credit cards, the home equity loan has become one of the hottest new areas in consumer lending.

Last year home equity loans (which are basically just second mortgages with a few bells and whistles added) amounted to $75 billion. That was also the 1984 level.

The pace of growth may get even faster. Beginning last month, the Federal Home Loan Mortgage Association (Freddie Mac) got into the business of buying groups of home equity loans and selling bonds backed by these loans to investors.

This should bring more thrifts into the equity-loan business and could, says Rebecca Stewart of Freddie Mac, result in lower interest rates for these second mortgages. Before last month, Freddie Mac was securitizing such loans only if they were used for home improvements. There was lackluster response to that program, however, so now the equity loans can be put to any use. Aggressive promotions

Use 'em for remodeling, for a new car or boat, for sending the kids to college, the ads urge.

Banks, thrifts, and other financial institutions are aggressively promoting home equity loans, often telling potential borrowers that their income and creditworthiness don't matter; all that matters is the uptapped equity in one's home. Some estimates put this untapped equity at $4.3 trillion nationwide -- in part because of the huge run-up in real estate prices nationwide in the 1970s.

Many banks have even been offering to carry the cost of fees for title searches or contract preparation. This can make equity loans more attractive than second mortgages, since one often has to pay points and closing costs on the latter.

With most equity loans, you can qualify for up to 70 or 80 percent of your home's appraised value, less the balance due on the first mortgage. Interest rates vary from lender to lender, but they are generally a couple of points above prime, which is a lot better than one can get on a credit card.

There's one more reason home equity loans may be getting more popular soon.

If some semblance of President Reagan's tax reform proposal is enacted, it may include a provision that limits deductibility of interest payments strictly to first homes. A home equity loan could be a way to pile debt onto your first mortgage to finance a vacation home, boat, or other items that wouldn't qualify for the interest deduction. That, of course, is a loophole in the making -- and lawmakers could quickly figure out how to close it. Debt is still debt

Before we go much further, a bit of advice: Be careful.

Home equity loans are still loans. They still need to be repaid. Your house -- or at least part of it -- is the collateral, and in a worst case, if you default the creditor could foreclose on your house.

Financial planners say there is a marked tendency among people interested in home equity loans to forget that these are actually loans. It's not like selling your house at a profit and getting cash.

``Your cash flow goes down [in servicing these loans], but that's not brought out too strongly by the banks,'' notes Vernon L. Woodrum, a financial planner in Charleston, S.C.

Still, Mr. Woodrum sees a place for the equity loan. One strategy he recommends to clients ``who are handy'' is to get a small equity loan ($5,000 to $10,000) on their home and use it to finance one or two low-priced rental houses. These can both serve as real estate investments and, because of current interest and depreciation deductions, help improve one's tax picture.

But this doesn't really have to be done with a home equity loan, Woodrum says. If you've owned your house for a while and have a relatively high interest rate on it, it might be a good idea to refinance at today's lower rates (10 percent or less) and take cash out of it for other investments and expenditures.

Even financial planners whose firms sell equity loans say they are cautious about recommending them.

At Merrill Lynch, Donald B. Dulmage, a vice-president for financial planning, says an equity loan should be used only for home improvement or higher education. He, too, worries about how people service those loans.

If you already pay homage to Visa, MasterCard, a department store or and the grantor of your auto loan, it might be tempting to use a home equity loan to consolidate your debts. In so doing, you can reduce your interest charges from the 19 to 20 percent range to 11 or 12 percent.

That's a smart move -- as long as you aren't simply freeing your credit cards only to begin running up charges again. You might get out the scissors and have a plastic-cutting session at the time you consolidate your loans. Inherent dangers

A home equity loan ``is another debt,'' says Michael Leonetti, a financial planner in Arlington Heights, Ill., and president of the National Association of Personal Financial Advisors.

``Normally people take out home equity loans for immediate enjoyment. But you don't want to take on debt today in our low-inflation economy. In the past you might have wanted to.''

In fact, with a few exceptions, real estate prices throughout the US have been stagnant. In some locales where there were rampant speculation and overbuilding in the 1970s, prices have actually been dropping.

In such (admittedly rare) cases, it is conceivable that a seller with an big outstanding balance on an equity could end up owing more than the sales price of the house.

``American consumers,'' says Mr. Leonetti, ``are hearing that interest rates are going down and that now is the time to borrow. But other factors to consider are inflation and the real rate of return.''

In other words, don't expect inflation to outstrip your interest payments, as in the old days. You can't beat the bank in the current economic environment. Borrowing against your home, like any other kind of borrowing, puts you in debt. Period.