For Many, Home Equity Equals Favorable Loan
Over the past year, soaring housing prices have been providing a windfall for many Southern California homeowners needing some extra cash.
Fueled by strong demand and limited supply, house prices have climbed by one-third or more in some areas. In the San Fernando Valley, the median price in March was a record $230,000, up $58,000, or nearly 34%, from $172,000 a year earlier. In Orange County, the median price was $237,409 in February. That’s an increase of $57,652, or 32%, in just one year.
Prices have risen so quickly that people who have owned their homes for just a few years are finding that they have built up $100,000 or so in equity--the difference between what their houses are worth and what they still owe.
In increasing numbers, owners are converting that equity into cash. They’re doing it by taking out home equity loans or home equity lines of credit--two types of financing that have surged in popularity with the heat of the housing market and the changes in tax laws.
Many borrowers are using the funds to fix up their houses by building additions and otherwise making do with their present quarters because they cannot afford to buy bigger houses, lenders say.
Home Remodeling
“With the cost of housing today, there’s a greater focus on remodeling a home rather than moving up to a bigger house, which carries a higher price and higher monthly payments,” said Michael E. Cichon, senior vice president for residential lending at Great Western Bank, a Beverly Hills savings and loan.
Some homeowners are refinancing original mortgages to get extra cash, but refinancings have slowed considerably. That’s because interest rates have risen and because many of the people who took out mortgages when rates were high several years ago have already refinanced them.
Refinancing also takes longer, costs more and the qualification rules are stricter, although the interest rates would be lower than those for home equity loans, lenders say.
Besides financing home improvements, equity loans and credit lines are often used to consolidate consumer debts such as automobile loans and credit card charges, lenders say. Other purposes include paying off medical bills and college costs and financing a small-business venture.
Some affluent Southern California residents are borrowing against the equity in their homes to make down payments on duplexes, apartments and other rental properties, said Stephen P. Renock IV, senior vice president at Shearson Lehman Hutton Mortgage Co. in Newport Beach.
Some Reasons Less Sound
All of those are considered to be good reasons to take out equity loans, because in each case there is some genuine benefit derived. But lenders are also finding that borrowers are using equity loans for frivolous expenditures that they often cannot afford, such as luxury cars, expensive vacations and even gambling losses.
Borrowers who fail to make these loan payments won’t be confronted by collection agencies threatening to ruin their credit records. Rather, they will hear from banks that have the legal right to take their homes away. The ultimate risk in an equity loan is foreclosure.
“The bottom line is that a home equity loan is not a safe solution for a poor money manager,” said Kenneth Slezak, owner of Vista Marketing Services, a Huntington Beach consulting firm for the banking industry.
In fact, consumers who are having trouble handling their debts usually are dissuaded from using a home equity loan to consolidate them, said Carl F. Lindquist, president of Consumer Credit Counselors of Orange County, a nonprofit organization that counsels borrowers overburdened with consumer debts.
Lenders say an important motivation behind equity loans being used to consolidate debts has been the change in federal tax laws. Under the 1986 Tax Reform Act, the deductibility of consumer loan interest is being phased out, but interest paid on home loans remains deductible.
Only 40% of the interest paid on consumer debts last year was deductible on 1988 income tax returns. And next year, said Robert J. Weber, vice president and product manager for Security Pacific National Bank’s home equity programs, the deduction for consumers “drops to 20% of the interest they’re paying this year. Most people probably are consolidating their consumer debts into equity loans right now.”
Deductible Interest
Interest on home equity loans is deductible as long as the loan does not exceed $100,000 or the owner’s actual investment in the house, whichever is less. The investment amount consists of the down payment, any mortgage principal already paid off and any amount paid for home improvements; it does not include appreciation.
Therefore, someone who bought a house for $150,000, built a $30,000 addition and still owes $100,000 on the mortgage could borrow up to $80,000 through a home equity loan, the interest on which would be tax-deductible.
If the home has appreciated enough to be valued at, say, $250,000, the owner could take out a bigger loan, but interest paid on any amount over $80,000 would be deductible only if the money were used for home improvements, education or medical expenses.
“In today’s environment, the first thing you should do is talk to a tax adviser,” Weber said. “Then you should look at why you’re taking out the loan.”
Home equity loans are also known as junior mortgages. A borrower receives a fixed sum that is typically paid back in equal monthly installments over a period of five to 15 years. The lender has a secured interest in the residence.
Home equity lines of credit are similar, except that a borrower is given a spending limit like that on credit card accounts rather than a fixed sum of money. The borrower can draw cash and pay off the loan much like he or she would a credit card balance.
