CONSUMERS : Calculating the Real Costs of That Home Equity Loan
Thinking of getting a home equity loan so you can pay off some of your credit card debts, put a new roof on your house, finance an expensive car or send your son or daughter to college this fall?
That’s not a bad idea, but keep in mind, it’s buyer be careful. You better check out the company that’s offering the loan and know what you’re getting: Are there fees and points to pay, closing costs, charges for using the credit line? What can you deduct from your taxes? Can the variable interest rate suddenly change from 12% to 20%?
If you don’t know the answers, you may find yourself in a messy situation. If you can’t make your home equity loan payments, you could lose your house or condominium.
‘A Beneficial Tool’
“A home equity loan can be a beneficial tool to consumers, but they should be very careful and know what they’re getting or they can get buried by these,” said Stephen Getzoff, an accountant and financial planner in Beverly Hills. “Home equity loans are a tool and they should know how to use one. Would you give someone who didn’t know anything about real tools a power saw? No. They’re liable to cut an arm off.”
Getzoff and other financial advisers do not recommend taking out such loans against your property for “frivolous” reasons, such as a cruise or a new wardrobe, or if you only owe a small amount of money on your credit cards.
“I wouldn’t recommend them for vacations, cars or entertainment spread out over 30 years,” he explained. “But under certain circumstances, for relatively short-term needs--buying a car and paying it off in three or four years--that’s OK.”
Home equity loans have been growing in popularity with homeowners since the Tax Reform Act of 1986 began reducing deductions for finance charges, such as those for credit cards, costly appliances or car loans.
So taxpayers started looking for other ways of finding deductions, converting consumer loans into home equity or other mortgage-related loans.
And the figures uphold the boom in home equity loans. In 1987, for example, home equity loans in the United States nearly doubled--increasing from $40 billion in 1986 to $72 billion.
Under the law, you could deduct only 40% of your consumer interest on your 1988 tax return; only 20% will be allowed for the 1989 tax year; 10% for 1990, and zero thereafter.
You can borrow up to $100,000 on a home equity loan and still write off all the interest. But loans secured by real estate can’t exceed the fair market value of your home. If it’s worth less than $100,000--unlikely in Southern California--you can only deduct interest on its actual worth.
Do Some Calculating
If you’re considering a home equity loan, sit down with a pad, pencil and calculator and figure out your yearly total consumer debt--credit cards, car loans, what appliances you’re buying on time.
Say, for instance, if you have $15,000 in consumer debt, you’ll probably pay about 18.6% interest on it, a total of $2,800 in annual finance charges. You can only deduct 20% of those charges, which comes to $560.
If you take out a $15,000 home equity loan at 12%, your interest charges will be about $1,800, depending on fees or points you have to pay. Because your loan is secured by your property, you can write off all of that.
Lenders are currently offering all sorts of home equity loan “deals,” and most financial and real estate analysts predict that they will become additionally creative with the home equity loan market as the consumer appetite for them continues to grow. That creativity may confuse consumers even more.
Observed Nancy Everett, senior vice president and real estate loan expert with Great Western Bank: “This is just the tip of the iceberg in terms of how competitive this arena will be.”
It’s not just tax reform that’s causing the home equity phenomenon, Everett said. It’s also a largely untapped market: total equity in single-family homes is estimated to be between $2 trillion and $4 trillion.
“We think in many cases consumers don’t really understand home equity loans,” said Ken McEldowney, executive director of Consumer Action, a San Francisco-based watchdog group that conducted a 1988 study on property equity loans. “There are very serious questions about a lot of credit approaches, and a degree of non-bank direct mail and telemarketing that we have reservations about.
“There are dangerous pitfalls and consumers should use great caution. Those brochures hyping vacations, yachts and clothing are totally unwarranted. People should only get these (home equity loans) for something of significant value.”
McEldowney explained that one of the serious problems for consumers seeking home equity loans can be that the lenders may unilaterally change the terms of the loan, increasing the variable rate because there is no current law that mandates they must have a cap on the rate. Or the lending institution may not disclose that it can change the index to which it ties the variable rate.
Because of increasing consumer concerns about disclosure and other lack of safeguards on home equity loans, Rep. David E. Price (D-N.C.) introduced national legislation concerning home equity loans last year. Called the Home Equity Loan Consumer Protection Act, it passed both the House and the Senate and was signed into law in November, but really won’t affect today’s consumers getting such loans.
Because it took longer for the Federal Reserve Board to write the regulations for the bill, it is not expected to be fully implemented until late summer or early fall, according to a spokeswoman for Price. But she said that some lenders are already following the new regulations.
What these new rules require is a series of key disclosures to the consumer when given the loan application, such as points and fees, and that lenders have a cap on the variable loan rate (but it does not limit the amount of the cap). They also forbid misleading ads about the price of the loan, and prohibit lenders from unilaterally changing the terms of the loan.
Some things to look out for when shopping around for a home equity loan:
--Check out the lending institution because some “hard money lenders” like finance companies may charge more than banks, savings and loans or stock brokerages.
--Make sure you know upfront what the interest rate is and if it is based on the prime rate or some other index like the Treasury bill index often used by lenders. What is the cap on the variable rate, and how often can it change? That will vary among lending institutions.
--Ask for a total of all the charges on the loan, including paying points or a fee, the appraisal charges or cost of the credit check.
--If your home equity loan gives you a credit line, with use of either a credit card and/or checking account, will you have to pay a service charge every time you use it?
--Ask your tax preparer or financial consultant to go over the loan with you to make sure what’s deductible under the new tax law, or if you’d be better off with a straight second mortgage loan on your property, where the interest rate is often lower and fixed and still deductible on your taxes.
--What is the monthly payment and does it pertain only to interest on the loan, requiring a “balloon” payment at the end of the life of the loan? If not, what amount each month goes toward the principal of the loan? Is there any kind of “grace” period for late payment if you have extenuating circumstances, such as illness or job loss?
--If you decide to take out the home equity loan, make sure that the lien the lending institution places against your home as collateral for the loan is registered with the county recorder. This will assure that the money you borrowed is mortgage debt and deductible from your income tax.
