Consumer Borrowing : Big Growth Seen in Home Equity Loans
By sharply curtailing consumer interest deductions, congressional tax writers have handed consumers one more reason to own a home and set the stage for a spate of new home equity consumer loans.
Such loans, which have become increasingly popular with homeowners over the last five years, allow consumers to use their homes as banks. Once tax overhaul becomes law, they will be the only way for borrowers to deduct the interest payments on money they borrow for cars and other consumer goods.
“You’re going to see a more competitive financial services market,” predicted Charles E. Newcomer, a spokesman for General Motors Acceptance Corp., the automobile and mortgage financing arm of GM. “With lower tax rates, people will have more money to spend . . . and they’ll shop around more for creative loans.”
Under the sweeping tax revision legislation approved late Saturday by congressional conferees, consumers may continue to deduct all interest payments on their principal residence and on a second home.
Deduction Phased Out
But the interest that consumers pay on credit card charges, car loans, school loans and other consumer borrowing will no longer be deductible from taxes from 1991 on. The deduction will be phased out gradually over the next four years--35% of such deductions will be disallowed in 1987, 60% in 1988, 80% in 1989 and 90% in 1990.
Only homeowners can get around that change. Regardless of how they spend the money, homeowners who borrow against the equity in their homes will be permitted to take a deduction for at least part of the interest payments on that loan.
The tax conferees recognized this as a loophole and made a nominal attempt to close it. So, in its final form, the bill permits deduction of interest on loans equal to the original purchase price of the home, plus an additional allowance for home improvements. In addition, the borrowing ceiling is raised by the amount of equity-based loans taken out to pay medical bills or put children through school.
For example, a couple who paid $100,000 for a house, have a $70,000 mortgage on it and have spent $10,000 on home improvements would be allowed an interest deduction on a $40,000 home equity loan. If they needed the money for medical or educational bills, the $40,000 limit would be increased to include the amount of those expenses. Although tax laws would permit a loan of $40,000 in this case, lenders normally make loans on no more than 80% of the equity in a home.
Consumers may still borrow as much as their lenders will give them, of course. But they will not be able to deduct the interest over the amount set by Congress.
This restriction is not expected to deter borrowing. But it is expected to cause an outpouring of protest from people whose homes are worth much more than they paid for them and from lenders--the latter because they are afraid they will be required to determine the purpose of home equity loans.
Tends to ‘Make Liars’
“We’re going back to the days of World War II, when Regulation W said people could only borrow for certain reasons,” observed Gary J. Perkinson, a vice president at Beneficial Corp., the large consumer finance company. “It tended to make liars out of Americans.
“What this says to some of us,” he continued, “is that the thought-police are going to be out there saying, ‘How dare you take a vacation with money you said you were going to have a liver operation with.’ ”
Consumers whose homes are now worth far more than they paid will particularly be upset by this restriction, Perkinson said, because “their homes are a form of pension, and a lot of people are going to say, ‘I’ve got right to that money and a right to deduct that money.’ ”
‘Going to Be Very Upset’
“I don’t think this change will be enough to make people sell their houses and buy new ones,” said John J. Coneys Jr., a tax partner in the Los Angeles office of the Price Waterhouse public accounting firm. “But they are going to be very upset, and there will be pressure to change it.”
Some lenders are concerned that this interest curb gives Congress an excuse to further restrict interest write-offs on equity borrowing in future tax bills.
“It’s the camel’s nose under the tent,” said Beneficial’s Perkinson. “Every time the country needs a little more money, these bureaucratic munchkins . . . will dip in here a little bit more.”
Accountants are already advising clients to consolidate their loans--except their home mortgages--into one large loan backed by their home equity. And lenders are preparing to handle this expected demand with equity loans and lines of credit secured by a second mortgage.
Surge of Interest
Merrill Lynch’s 3-year-old equity access loan, for example, is already that firm’s most popular form of second-mortgage borrowing, and Charles A. Humm, a Merrill Lynch vice president, expects a surge of interest once consumers better understand the tax bill. It is a line of credit worth up to 75% of a homeowner’s equity that can be tapped any time. Merrill Lynch charges an annual fee of about $35 and a 2% origination fee plus an interest rate 2 percentage points above the prime rate on money actually borrowed.
Otherwise, lenders doubt that tax overhaul will cause any dramatic shifts in consumers’ borrowing habits.
Credit card issuers, for example, note that consumers’ overall credit card debt is up dramatically this year over last, even though tax revision and the proposal to dump consumer interest as a deduction has seemed a virtual certainty for several months.
Nominal Interest Charges
Credit card companies are further sanguine about the prospects of continued credit card use because, they say, consumers pay off about half of all credit card charges within the grace period--that is, before any interest is charged. And, for those who do incur interest on their credit card bills, the charge is nominal--$17 a month on average.
“We think the impact will be zero,” said Richard Woods, a MasterCard International spokesman. “People who use credit cards are looking for the utility of the card, not the price of it or the deduction of the interest.”
Companies that finance cars agree. “Fundamentally, people buy automobiles because they need transportation, not because it’s a good tax write-off,” Newcomer of GMAC said.
