Home equity loans carry caveats

October 14, 1994|By Andrew Leckey

Financial flexibility is a wonderful thing, so long as you don't hang yourself with it.

Use of home equity lines of credit is on the rise, now encompassing one out of every 12 American homeowners. Heavy promotions offering special deals to sign up should push that figure higher.

Borrowers have grown accustomed to this ready source of cash. So much so that 62 percent of the available credit from the nation's home equity lines is currently loaned out, according to a consumer survey by the University of Michigan.

Homeowners still use the money to make home improvements. But, increasingly, they're also using it for debt consolidation, vehicle purchases and education costs, and to finance small businesses when banks haven't been willing to make traditional loans.

"One couple used their home equity loan with us to cover the considerable expenses tied to adopting a baby," related Paul Huff, senior vice president at First Union Home Equity Bank in Charlotte, N.C. "But while we do ask what they'll use the money for when they apply, we don't track the use of it later."

Interest on up to $100,000 of a home equity line of credit is fully deductible, so long as the loan is secured by your principal home or a second home that you own. You apply for a loan, pay closing costs just once and then borrow as needed. You can usually borrow up to 80 percent of your home's appraised value, minus any existing mortgages.

"My wife, Vicki, and I got a home equity line of credit when we bought our home because we knew we'd be using the money for landscaping and the deck we built on the back," explained homeowner Larry Schaal of Arlington Heights. "Then, when the engine block on one of our cars unexpectedly cracked several years ago, we were able to use the line of credit to buy a new car fast."

The Schaals try to set a specific period to pay off each borrowing from their credit line, realizing that, since they aren't required to pay off any principal each month, it's easy to lose sight of how much has been borrowed.

For many homeowners, the price of these loans is right.

"The rate for home equity loans, a point or two over the prime lending rate [the national average is 1.5 percent over prime], is the lowest consumer rate available, with the exception of first mortgages," said George Yacik, vice president with SMR Research Corp., Budd Lake, N.J., which tracks consumer finance trends.

Furthermore, seven out of 10 lenders are currently waiving a majority of their fees to snare new borrowers. Fritz Elmendorf, vice president with the Consumer Bankers Association in Washington, said competition has clearly "heated up" in the form of low introductory rates, waived fees and other promotions. So if you feel you need a home equity loan and can handle it, it pays to shop around for the best terms.

"The limitations of the home equity loan rules are based on how you borrow the money, not on how you spend the money," said Robert Greisman, tax partner with Grant Thornton. "If you borrow the money under those rules, no matter what you use it for, the interest will be deductible."

Of course, there's another side to all this financial flexibility. The temptation is obviously great to overuse or misuse these handy vehicles. Never open a larger line than is necessary, and use it only for solid reasons.

Restraint is crucial because your home could be repossessed if you fail to make good on your debt. Some people treat home equity loans as permanent debt that will simply be paid off when a home is sold, but, in general, you should try to set your own period for payment comparable to what it would have been had you obtained the money through a conventional loan.

In addition, beware of unethical sales practices involving home equity lines of credit.

"One vision-impaired woman was pressured by a salesman to consolidate all her debts into a home equity line of credit and she literally couldn't see she was signing a paper for a one-year balloon loan at 36 percent interest," said Susannah Goodman, legislative advocate for Public Citizen in Washington, who lobbied for the Home Ownership and Equity Protection Act recently signed into law, which tightens requirements on issuers of home equity loans.

Public Citizen offers this list of consumer "don'ts":

* Don't take big promises on home equity loans at face value.

* Don't deal with anyone who contacts you.

* Don't blindly trust even seemingly nice people from your community or your church that aren't from established lenders.

* Don't trust home improvement contractors to get you a loan, but instead get the loan before you hire the contractor.

* Don't sign the same day you first receive information.

* Don't sign any forms with blank spaces.

* Don't try to roll all of your debt payments into one so that your home hangs in the balance.

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