Home-equity loans lose some appeal with tax reform, but they remain good

Home-equity loans seem almost too good to be true. With credit cards around 18 percent and car loans in the low teens, Americans can get sizable home-equity loans for just a few points above the prime lending rate.

In some parts of the country, home-equity loans are being offered for 6 to 7 percent.

But under the new tax laws, home-equity loans are not quite what they used to be. The most important change: loss of interest deduction in some cases.

A home-equity loan, no matter what a bank calls its particular version, is actually just a second mortgage. It is secured by the equity you have in your residence.

Under the new tax laws, mortgage interest is still deductible -- but only if your mortgages do not exceed the original purchase price of your house plus the cost of improvements. Appreciated value is not a factor, with the important exception of paying for educational or medical expenses.

Gone are the days of being able to finance everything -- from a boat to a fur to a vacation in Aruba -- at a low rate and deduct the interest just because your house is rising in value.

Let's say you buy a $150,000 house. You put $40,000 down and add some $10,000 in well-documented improvements. So your mortgage is $110,000; your equity is $50,000.

A bank will usually lend only about 80 percent of your equity: in this case, $40,000. In a hot housing market, you might get more, but that is paper equity, not real (therefore deductible) equity.

In this example, you'd be able to deduct all the interest charges on that $40,000, since your mortgage plus equity loan adds up to only $150,000.

If your property appreciates, say, by $50,000 by the time the kids are in college, you could possibly tap that equity for their education and still take a deduction on the financing.

If you have have an equity loan for whatever purpose, based on assessed value, granted before Aug. 16, 1986, all of the interest will remain deductible for the life of the loan, according to the new tax law. That's only fair, since you probably initiated the loan under the old rules.

There is a patch of gray in this grandfather clause, however.

Some banks have designed equity loans as lines of credit to be tapped when needed. You could, for instance, have a $60,000 equity loan based on the appreciated value of your house, but you might have drawn out only $20,000 so far.

Reading the new tax bill, Michael Meyer, a manager at Deloitte Haskins & Sells in Chicago, says it looks as if you will not be able to access the unused $40,000 (except, of course, for educational or medical reasons) and be able grandfather in the interest deduction.

This and other tax-law changes make equity loans less wonderful than they used to be. But they still are attractive.

Even though you won't be able to deduct credit card, auto loan, or boat loans any longer, you still might need or want one. But their interest rates are much higher than home-equity interest rates. So it may advantageous to roll your non-deductible borrowing into an equity loan just to get the lower rate.

Do bear several points in mind: The bank may charge you points and loan processing fees; super-low rates may be the result of first year ``buy-downs'' by banks; the loan is usually adjustible and could rise sharply if the index (such as the prime rate) jumps.

Finally, remember that equity loans must be serviced and paid back -- and your house is partly held hostage.

``If something goes wrong,'' notes Steven Spectors, a tax manager at the Arthur Andersen & Co. accounting firm in Chicago, ``do you want them to come after your house? Or your boat?''