More and more homeowners are opting for a home equity line of credit. They figure that if they must borrow money, they might as well get a tax deduction for the interest they pay.
By the end of this year, Americans will have borrowed more than $100 billion on home equity lines - "enormous growth," according to David Olson, a financial analyst with SMR Research.He estimates about 5 million of the nation's 110 million households have such credit lines (another 8 million have standard second mortgages) and says the number is increasing rapidly for two reasons:
- Homeowners who find they can't sell their house in a depressed market or can't afford a bigger home have increasingly turned to remodeling, adding a sun room, extra bedroom, family room or luxurious bathroom. Many pay for these expensive improvements by drawing equity out of their homes.
"If you can't sell your house because real estate values have fallen, you make an addition onto it and you borrow on a second mortgage," Olson said.
- Starting Jan. 1, none of the interest you pay on credit card debt, car loans or most other forms of borrowing is tax deductible. But you can still deduct from federal income taxes the interest on up to $100,000 on a home equity loan in most cases.
Lenders like to make home equity loans because the profits are good and the risks are small; few homeowners default. Consequently, in many towns, the competition for your business is stiff and the offers are good.
To figure out how much money you could borrow on your home, estimate how much it's worth and multiply that figure by 80 percent. Then subtract the amount you owe on your first mortgage. The remainder is the amount you probably could borrow on a home equity line of credit.
For example, say your house is worth an estimated $150,000. Multiply that by 80 percent (0.8) to get $120,000. Subtract the first mortgage - $80,000. That would leave $40,000 available for a home equity loan.
While most lenders offer credit lines on 80 percent of the equity in a home, some will lend only 75 percent and a few will lend 95 percent or more. Check with several lenders in your area to see what's available.
Which home equity loan is best?
As a rule of thumb, if you plan to borrow a lot of money right away and pay it back over the long term, look for a lender with the lowest long-term interest rate and you pay the closing costs.
If you plan to borrow right away but will be able to pay back the money quickly - say, in a year or two - look for one of the "teaser" rates that offer a low rate for six months, then increase.
If you don't plan to borrow much, look for a loan with no closing costs.
Currently, some lenders are offering home equity loans with interest rates at or near the prime rate - 10 percent.
In Hartford, Conn., Suffield Bank advertises an interest rate of .5 percent over prime or 10.5 percent. You also must pay one point - 1 percent of the loan amount. An alternative is a rate of 11 percent with no points or closing costs.
Manufacturers Hanover in New York has a rate at prime - 10 percent - for homeowners who borrow $75,000 or more. You pay closing costs.
Other lenders offer fixed rates, which are similar to the standard second mortgage.
In Virginia, First Virginia Bank offers a fixed rate of 9.99 percent if you can pay the loan off in five years. You pay no points, but there are closing costs.
In Maryland, the Mellon Bank has a fixed rate for 15 years with an interest rate of 10.99 percent. Again, no points, but you do pay closing costs.
Not all areas offer good rates. A survey by the Bank Rate Monitor, a trade publication, found that many home equity loans in south Florida carried long-term interest rates of prime plus 2 percentage points - a hefty 12 percent.