Credit on the house
© St. Petersburg Times
When Alyssa Wilson decided to remodel a bathroom in her St. Petersburg home last year, she knew right away how she wanted to pay for it: a home equity line of credit.
"I knew that the interest was deductible and the rates were really good," she said. "It seemed like there were no downsides."
Of course, there are always downsides. If your loan has a variable rate, it won't be nearly so attractive when interest rates go back up. And far worse, if you can't pay back a home equity loan, you lose your house.
Those more or less distant possibilities have done nothing to slow a huge boom in the loans. Taking advantage of low interest rates and rising housing values, one in four homeowners with a mortgage now has some type of home equity loan.
Most home buyers take out a first mortgage for 15 to 30 years to finance the purchase. As they pay down the mortgage and as housing values rise, they build equity: the difference between the value of the property and the amount owed on the mortgage. That equity becomes available to use as collateral for a home equity loan or credit line.
The biggest chunk of the $1.1-trillion homeowners have borrowed is still in traditional home equity loans, the kind where you borrow a lump sum, usually at a fixed rate, and make regular monthly payments.
But new borrowers are moving in a different direction. The big growth is in home equity credit lines, flexible loans that homeowners tap as they need the money, using a check or a debit card. The interest rate fluctuates, typically with the prime rate, and so do the payments. Pay down the loan and you can borrow the money again later.
'The major story the last few years has been the rebound in lines of credit," said George Yacik, vice president of SMR Research Corp., a New Jersey company that tracks financial products. The company's research shows the dollar volume of outstanding home equity credit lines has more than doubled in the past three years. It was up 34 percent last year alone.
'Home equity borrowers have shifted their preference to open-end lines of credit simply because the prices are so much lower," he said. "They're just a good deal now. With rates under 5 percent, it's kind of a no-brainer which product to take."
Home equity credit lines were available at an average of 4.78 percent interest last week and fixed rate loans at an average of 7.62 percent, according to statistics compiled by Bankrate.com. And many banks offer much better deals.
Several in the Tampa Bay area advertise credit lines at 4.25 percent interest with no closing costs. However, you have to read the fine print to be sure you understand the terms. Some banks charge an annual fee, and some make the waiver of closing costs contingent on borrowing a minimum amount or on keeping the line open two or three years.
The credit line Alyssa Wilson chose carries a prepayment penalty if it is closed within two years, even if she had never tapped into it for a loan. She said avoiding several hundred dollars of closing costs was worth the risk that she might decide to sell her house, requiring her to close the equity line and pay a penalty.
If interest rates begin rising, so will rates on credit lines, which means people who have been counting on low payments could find themselves in a pinch. As recently as 2000, the average rate on a home equity credit line was more than 9 percent. One credit line now being advertised at 4.25 percent has an interest rate cap of 18 percent.
Usually home equity loans and credit lines carry higher interest rates than first mortgages because the collateral is less secure. If a homeowner defaults, the home equity lender is repaid after the first mortgage lender.
The number of new credit lines is growing at an even faster pace than the dollars outstanding because people are refinancing home equity credit lines just as they are first mortgages.
"Many people are closing a smaller line and opening a new, larger line," said Monica Martines, spokeswoman for Third Federal Savings, where new lines of credit were up 43 percent last year. She said it has become common for people to refinance their first mortgages and take out a separate home equity line of credit at the same time.
"We theorize that customers refinance, taking cash out to cover outstanding debt, and then take out an equity line of credit for cash if needed," she said. The average credit line at Third Federal is $51,329.
The ease of tapping a credit line is one of its biggest selling points -- and ultimately one of its biggest disadvantages, because the money does have to be paid back eventually.
It took no time at all for Wilson, 34, to discover how handy it can be to have a home equity credit line in place. While she was remodeling the bathroom, her roof needed replacing. Then her car broke down, and she wanted to buy a new one.
"The $20,000 (credit line) was enough to cover the roof, but not the car," she said. Wilson initially took out a car loan to buy a 2003 Toyota Matrix. Later she paid off the car loan and consolidated her debt by increasing her credit line to $45,000.
"I played it smart this time and left myself a little wiggle room in case anything else unexpected comes up," she said. "I have a 50-year-old house, so there are always going to be things that happen."
Debt consolidation and home improvements are the top two uses for new home equity lines, according to the Consumer Bankers Association. Many people also use them to buy cars and pay college tuition bills.
It's a convenient way to turn nondeductible interest on credit cards and car loans into deductible interest. Generally, interest is deductible on equity loans of $100,000 or less, just as mortgage interest is deductible. The $100,000 limit is separate from whatever is owed on the first mortgage.
New Port Richey real estate broker Kevin Horan uses the home equity credit line he took out last year to finance short-term real estate deals.
"The banks trip over themselves trying to lend you the money," he said.
Clearwater resident Ebe Bower said she had no immediate use for the money but opened a credit line as a potential source of emergency funds.
"We took it out as insurance in case something happened to our earning power," she said.
Many banks charge nothing to keep a credit line open with no balance due.
A growing use for equity loans and credit lines is to pay off a first mortgage that has a small remaining balance. Many mortgage lenders are not interested in refinancing a $25,000 or $30,000 debt. Even those who are willing are likely to offer an inferior rate to the one they would give a customer taking out a larger loan. On top of that, those refinancing first mortgages are expected to pay hefty closing costs. Often it's just not worth it.
Instead of being stuck with a high-interest first mortgage, a homeowner can use a home equity loan to pay it off. A plus: There is no escrow account with a home equity loan. You control the payment of real estate taxes and insurance premiums.
Even with all the advantages, it is important not to forget that using your home as collateral places it at risk. Credit counselors discourage use of home equity loans for debt consolidation unless you know you can manage the payments and you cut up your credit cards at the same time. Otherwise, it becomes all too easy to run up new balances on the credit cards and end up in worse financial shape than you were before you took out the home equity loan.
Also, credit card debt can be wiped out in bankruptcy, but mortgages, home equity loans and credit lines have to be repaid if you want to keep your house.
Home equity loans and credit lines have a fixed life, generally five to 15 years, but the minimum monthly payment may not be enough to repay the loan over that period. At the end of the term, you may be required to pay whatever balance remains as a lump sum, or refinance. As with any financial product, it is crucial to understand what you're getting into.
Also keep in mind that taking out a home equity loan or credit line is, in effect, spending the equity in your house. Unless you pay it back, what you spend will be money you don't get when you sell your house. This is an especially important consideration if you have few other assets.
Real estate broker Horan said he sees the sad results at closings.
"Some have to sell their homes soon after spending this money and after paying closing costs only wind up with what they owe," he said. "Home equity should be used as a last resort, since the majority of people's net worth is this dollar amount."
Although credit lines have more sizzle, traditional home equity loans can be a better fit if you want to borrow a single lump sum and eliminate the temptation to borrow more than you really need with an open credit line.
People opening credit lines tend to be wealthier than average. The Consumer Bankers Association said its latest survey showed the average home equity borrower has a household income of $83,998 and lives in a house appraised at $208,556.
Alyssa Wilson, who works in marketing for a dental supply company, said she is pleased with the way her home equity credit line has worked out.
"The bathroom turned out great," she said. "I have a nice, pretty new roof on my house. I love the new car that I bought. Everything turned out great in the end."
-- Helen Huntley can be reached at firstname.lastname@example.org or (727) 893-8230.
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