Home-equity loans: Need or greed?

Andrew Leckey

October 01, 1993|By Andrew Leckey | Andrew Leckey,Tribune Media Services

Sparked by low interest rates, home-equity debt has become immensely popular, skyrocketing to a half-trillion dollars.

Using your home as collateral can indeed get you a loan more quickly for a more reasonable rate. Furthermore, you'll likely be allowed to deduct the interest on your taxes. However, it also increases your chance of losing your home one day and may provide more temptation than is best for your financial well-being.

"I have a bias against home-equity borrowing, because I don't like to see people pay for expendable items -- such as clothes or a car that loses value -- with a long-term loan," warned Sally Jo Button, a certified financial planner with Button Financial in Denver. "It encourages consumers to become greedy and decreases their chance of building their net worth."

Whether it's in the form of a line of credit that permits you to borrow up to your credit limit or a second mortgage for a fixed amount, home-equity borrowing is serious business. Lenders may let you borrow up to 85 percent of the appraised value of your home, minus the amount you still owe on your first mortgage.

"It can mean trouble when you use home-equity lines to refinance credit card debt, since this may enable you to dig yourself an even deeper hole, carrying not only the line of credit but new credit cards as well," warned Gerri Detweiler, executive director of the nonprofit Bankcard Holders of America in Herndon, Va.

It's best to use home-equity debt only for major items such as education, home improvements or medical bills. However, with lenders increasingly permitting not only traditional check-writing, but convenient credit cards and teller machine cards, unnecessary purchases become more possible.

According to the Consumer Bankers Association, a trade group in Arlington, Va., 34 percent of home-equity borrowers use the money for debt consolidation, 31 percent for home improvement, 10 percent for a car, 9 percent for education, 4 percent for vacation, 4 percent for investment, 3 percent for business expenses, 1 percent for tax payment, 1 percent for medical costs and 3 percent for other uses.

"Don't be tempted to buy a car with a line of credit without considering that you need to retire the debt on that car, and don't buy a more expensive car than you'd have bought otherwise," counseled Fritz Elmendorf, vice president of the association.

"Keep in mind that property values these days are likely to be flat, or actually down in some regions, so you can no longer expect an increasing amount of equity in your home."

A home-equity loan may not be the most appropriate type of loan for you.

"Before you even consider talking to a loan officer about home-equity possibilities, consider that there are other ways to borrow, such as installment loans for a set amount of money for a specific need or project," advised Carole Reynolds, a senior attorney in the division of credit practices at the Federal Trade Commission.

In a home-equity loan, expect an application fee, title search, appraisal, attorney fees and points, she said. In the case of special introductory discount rates, find out how long they last and what the rate will be thereafter.

"The majority of our home-equity line of credit customers have a 10-year period in which they can write checks and then there is either a 10- or 15-year payback period after that," explained Deborah Straughn, vice president with Chemical Bank. "So they have their credit lines for a total of 20 to 25 years."

When shopping for home-equity vehicles, find out the initial rate of interest and whether it's fixed or variable, and upon what index the variable rate is set. A specific percentage over the prime lending rate is common. Find out how often the rate charged can change, as well as whether there's a cap or floor on it. Ascertain whether there's a term on the credit line or if it's open-ended. Is there a balloon payment at the end of the term?

Know whether points are charged and the maximum percentage of the value on the home available for the loan.

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