Lenders are rushing new home-equity line-of-credit programs to market in the wake of tax reform, but financial planners and other experts are waving a caution flag to warn homeowners who are thinking about tapping the equity in their house for extra cash.
"If you go out and buy some furniture and then stop paying your bills, the company can come and take your couch," says John Cahill, a partner in the financial planning firm of Carroll/Cahill Associates in San Francisco. "But if you don't make your payments on a home-equity loan, the lender can take your house."
Adds Lawrence Krause, another San Francisco financial planner, "If you're going to borrow money, you should have a reason--don't borrow just because you have some equity in your house. Have543236208money."
Homeowners across the country began being inundated with advertisements and direct-mail pieces from lenders anxious to give them a line of credit based on the equity they have in their home a few months ago.
The media blitz was triggered when Congress decided to retain tax deductions for mortgage-related interest payments, but phase out deductions for interest payments on "consumer loans" for objects such as cars, boats, clothes and furniture.
Unlike a "pure" home-equity loan--which typically gives the borrower a lump sum of cash and is repaid at a specified amount each month over a specified length of time--most home-equity credit lines are open-ended accounts that allow the owner to convert their equity into cash simply by writing a check or using a credit card.
In effect, the accounts can allow homeowners to continue writing off interest payments for consumer goods because the loan is secured by real estate.
These credit lines are the financial "product of the 1990s," says Jerry Weeks, senior vice president of real estate operations at Beverly Hills-based Great Western Savings.
Advertising Paying Off
He notes that such programs can allow equity-rich homeowners to use the value of their homes to finance purchases ranging from a once-in-a-lifetime vacation to a child's education--and still deduct at least part of the interest expense at tax time.
Lenders' expensive advertising campaigns are already paying off handsomely. When Home Federal Savings & Loan Assn. recently sent out some 175,000 direct-mail letters about their home-equity credit lines, more than 7,000 homeowners had responded only three days after the first mailing went out. "That was triple our projections," says Dennis Casey, a Home Fed vice president.
But it's that kind of amazing response that has some financial planners concerned. Their biggest fear is that homeowners, lured by the credit lines' huge limit and easy access, may borrow money needlessly and have trouble paying it back later. In extreme cases, they say, such borrowers will lose their house because they've pledged it as collateral for their credit line.
'Playing Russian Roulette'
"You're playing Russian roulette with your house," Krause says. Since rates on most home-equity loans are adjusted monthly, he explains, "you're borrowing money and you don't know what your interest rate will be a year from now, or 10 years from now. And I think there's a real possibility rates could be a lot higher."
What type of homeowners are most likely to get in over their heads? Krause says it's probably people in their 30s or 40s who are already used to borrowing heavily. But others say it could be older people who have homes that are virtually paid off; if they dip too far into the equity in their home, they may have problems paying the loan back because their income could drop sharply after retirement.
Lenders, however, doubt there will be many foreclosures.
"There's not going to be a whole lot of people who will let us put a lien on their home without really understanding what they're getting into," says Casey at Home Fed.
Safeguard Against Defaults
Weeks at Great Western notes that the home-equity accounts his institution opens will be serviced by the company's credit-card operation instead of its real estate loan department.
He figures that should help safeguard against defaults because credit-card servicers are good at spotting and correcting a person's credit problems before they get out of hand.
"People shouldn't take out a home-equity loan simply for tax deductions," says Weeks. "It has to make good economic sense."
Financial planners agree that the accounts shouldn't be set up merely for tax purposes. But they generally reject lenders' claims that people should pledge their home as collateral for a loan to buy a boat or vacation in Tahiti.
Other Funding Sources
Instead, they say home-equity lines of credit should only be used to meet major, mandatory cash outlays and, unfortunately, they usually aren't the type of expenses people like to incur. Among those are meeting a child's college expenses, paying for expensive medical treatment or starting a business.