Home is where the money is. Which is fine, so long as you don't abuse the privilege of borrowing based upon the equity built up in that beloved home.
I've always recommended that consumers be cautious about taking out home equity loans. This popular form of revolving credit uses your home as collateral for borrowing whenever you please, for whatever you please.The real problem is that adding more debt to your home increases your chance of losing it one day. Many institutions have permitted customers to pay only interest due on the home equity loan each month, with principal not due for 10 or 15 years. Even then, the loan is renewable. A borrower can easily let things slide.
However, my warning may not be as necessary these days. Lenders are finally policing these loans. Spurred by a lagging real estate market, the savings and loan debacle, and stronger reporting requirements, they're instituting safeguards that they should've put into effect earlier. As a result, you won't find the spectacular deals in home equity loans of a year or two ago. Ultra-low "teaser" rates are a thing of the past.
Lenders are increasingly using the borrower's income, rather than the equity in the home, to determine maximum loan amount. They prefer that combined monthly debt expense, including all revolving lines of credit, not exceed 38 percent of gross income. Many lenders now permit a maximum loan of only 75 percent of equity vs. 85 percent in the past. Many have trimmed loans to five or 10 years.
A lot of S&Ls are getting out of the home equity market because of flat property values, increased loan delinquencies and general thrift woes. In addition, the Home Equity Loan Consumer Protection Act, which went into effect last November, requires more paperwork for lenders and therefore raises their costs.
Home equity loans make sense if you use them only for important needs, such as home improvements or educational expenses, and only if you're sure you'll be good about paying them off. A real positive: With a home equity loan, you can deduct interest on as much as $100,000.
"I like the home equity loan because interest is tax-deductible, unlike a regular credit card," said Lisa Riley, who used a home equity loan to fund the building of a new deck on the back of her Arlington Heights, Ill., home.
All home equity loans are not alike. "A wide variety of loans with differing repayment features are available, with some permitting interest-only payments, and most loans have variable rates pegged to the prime rate plus 1 or 2 percent," explained Glen Canner, senior economist for the Board of Governors of the Federal Reserve System. "Some have closing costs, though you can often find one that waives them if a special promotion is on." (The free booklet "When Your Home Is on the Line: What You Should Know About Home Equity Lines of Credit" is available if you send your name and address to Publications Services, Board of Governors of the Federal Reserve System, Washington, DC 20551.)
There are other reasons for using a home equity loan. "You see a lot of debt consolidation, in which people use a home equity line to consolidate at a lower rate all other debts, such as credit cards or a car or boat loan," observed Paul Havemann, vice president at HSH Associates in Butler, N.J., a firm that surveys the mortgage market. "Home equity borrowers generally are responsible users, with the lowest delinquency rate of any consumer loan."
Nonetheless, these loans were initially designed with strong home appreciation in mind. That, unfortunately, is no longer the case in many regions. Furthermore, delinquencies in such loans, though low, have been climbing.
"Fortunately, most people who obtain home equity loans do not use all their available limit," said Charles Campbell, a Wells Fargo Bank vice president based in San Diego. "They basically like a financial cushion and usually utilize half their available credit."
Still, home equity loans aren't for everyone. "People who could be hurt by a home equity line of credit would be those who tend to be large credit users, with perhaps $10,000 to $15,000 in existing charge card debt," said Paul Rayner, a vice president with NBD Bank in Evanston, Ill. "These would be the ones we'd counsel against taking one out."