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Home Equity Loan Calls for Careful Consideration of the Rewards, Risks

February 11, 2001|LIZ PULLIAM WESTON

Q The use of home equity loans has been a hot topic among my colleagues. We have read how people use them incorrectly for frivolous things, such as paying off credit card debt and then running up more credit card debt. But our question is, what is a good or at least reasonable use for a home equity loan? Should it be used to pay off student loans? How about remodeling the kitchen? Or having the loan available in case of emergency?

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A The answer to all of the above is: It depends.

Take the idea of refinancing your student loans by using a home equity loan to pay off the balance. The good news is that the interest on a home equity loan is usually tax-deductible. (Student loan interest is also tax-deductible, but only if your income is below certain limits.)

The bad news is that you've lost some flexibility. Most student lenders will allow you to temporarily suspend payments if, for example, you lose your job. By contrast, if you don't make your home equity loan payments, the lender can take your house.

Taking out a home equity loan to pay for a kitchen remodel has its advantages and disadvantages as well. You may find out it's a tax-advantaged way to improve the value of your home. Or you may find that you just spent a lot of money you won't get back when you sell because you made your kitchen way too fancy compared with others in your neighborhood. (Experts call that "over-improving" a home and generally discourage it.)

Again, the money must be repaid in good times and bad, so you'll want to be sure your job and finances are in good shape before putting your home at risk.

Borrowing money for no defined purpose--which is what you'd be doing if you took out a home equity loan and put the money in an emergency fund--is just daft. You're paying interest for no good reason. If you're worried about having money in a crisis, save some out of each paycheck or pay down your credit cards so you have some breathing room.

You could also think about opening a home equity line of credit, which is different from a home equity loan. Lines of credit are a kind of revolving account that work more like a credit card but with your home as collateral. Some financial experts do indeed advise opening such a line of credit in case you need it for an emergency later.

But again, you'll need to pay back any money you borrow or risk losing your home.

Long-Term Care

Q I am an insurance agent and wanted to tell you that you gave an excellent answer to the reader who was asking about long-term care insurance. I'd like to pass on an additional way of looking at who benefits from the insurance.

My mother is coming up on her first anniversary in a nursing home in Nebraska and will be there the rest of her life. She frequently worries aloud about how she will pay for her care.

I simply remind her that her long-term care insurance is paying for it and will do so as long as she lives. She smiles and says, "Well, that was a really good idea." That's the end of the subject--until she asks again in a few days. Not having to worry about money is a luxury we bought with long-term care insurance.

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A There are many types of insurance that are almost a no-brainer for most people. People who drive, for example, need liability insurance and usually lots of it. People who work for a living generally need disability insurance. People who have others who are financially dependent on them usually need life insurance.

Long-term care insurance isn't such an easy call. The coverage is still relatively new, and unfortunately some companies have greatly increased their rates after giving consumers the impression that they wouldn't.

Some people, like you, have had excellent experiences when their policies were needed. Others might find the coverage to be an unnecessary expense.

People with few assets, for example, generally don't need the insurance because the government will pay their long-term costs. People with lots of assets generally don't need it because they can pay their own way--although some people insist on having it so they can avoid spending "the children's inheritance."

So the jury is still out, although you can obviously be counted among the people who found the money well spent.

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Liz Pulliam Weston is a personal finance writer for The Times and a graduate of the personal financial planning certificate program at UC Irvine. Questions can be sent to her at liz.pulliam@latimes.com or mailed to her in care of Money Talk, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012. She regrets that she cannot respond personally to queries. For past Money Talk questions and answers, visit The Times' Web site at http://www.latimes.com/moneytalk.

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