As tax reform erodes deductions for consumer interest, people should take a second look at how they manage their credit, Merrill Lynch & Co. executives advise.
The executives suggested people shop for the lowest credit available, replace credit sources whose interest deductibility is being phased out and change credit habits."Most people - particularly upper-middle and higher income - could benefit from credit management," Charles A. Humm, a vice president of Merrill Lynch's credit management group, told a news briefing at the brokerage's New York headquarters.
"Already stung by 1987's interest-deduction phase-out, consumers may continue to lose interest deductibility on more than $600 billion of consumer credit in 1988 unless they reduce consumer credit now," said Dennis Hess, senior vice president and director of the firm's diversified financial services group.
While Hess acknowledged that one of the brokerage's motives for promoting credit management is to "cut the banks out" of certain fee-generating services, he also said many people are unaware of better ways to use credit.
With interest rates averaging 18 percent on credit cards and 11 to 16 percent on personal bank loans, consumers may find it worthwhile to use other types of credit.
Interest rates on home equity and securities-based credit, for example, run from 10 to 12 percent, depending on the amount and purpose of the credit, and could be completely tax deductible.
Home equity credit lines, offered by banks and brokerages, allow homeowners to use the equity in their homes.
Under the Revenue Act of 1987, anyone who establishes such a line of credit on a first or second home may be able to deduct all of the interest expense up to $100,000, regardless of how the money is spent, the brokerage said.
Interest on consumer credit was 65 percent deductible in 1987 and will be 40 percent deductible in 1988.
By 1991 deductibility will be eliminated. At that time, borrowers, for example, will pay annual interest of $3,900 on a $30,000 line of consumer credit at 13 percent. But annual interest expense on a $30,000 home equity line of credit at 10.5 percent will be $3,150 before taxes and $2,268 after taxes at a 28 percent tax rate.
"By using the home equity credit line, the borrower will save $1,632 a year," the executives said.