Home Equity Pleasures and Pitfalls

Home equity loans and lines of credit are more popular than ever, particularly as a way to consolidate debt. In fact, debt consolidation is listed as the biggest single reason people tap into their home equity. With interest rates lower than other forms of consumer credit, equity-backed debt consolidation loans can reduce your monthly expenses and may offer tax advantages.

So why the ominous headline?

Too often, undisciplined borrowers continue to overspend following debt consolidation, thus accruing more debt and hampering their ability to meet even their most basic monthly expenses.

In addition, many financial experts are concerned younger home owners, tempted by the daily barrage of home equity offers, are squandering their equity at the expense of their retirement needs. A Federal Reserve Board survey, "Recent Changes In U.S. Family Finances," found that home value accounts for 50 percent of the average household's net worth, and that many home owners rely upon equity income to supplement retirement.

Used wisely, home equity loans can be a relatively low-cost way to borrow money for big expenses such as college tuition and home improvements. Money management experts agree, it's best to use equity for things that have the potential to generate a return on your money — tangible things, such as home improvements and education.

With that said, before taking out a home equity loan, keep a few things in mind.

First of all, ask yourself whether you can take on more debt and, if so, how much. If you are going to use the money to make a large purchase, make sure it's something that will outlast the loan. Don't put your house on the line for a vacation to Aruba.

If you decide to take the home equity route, make sure there aren't any errors on your credit report. A good credit report can save you a few points in extra interest. And, trite as it may sound, always read the fine print in your loan agreement, and be on the lookout for points and closing costs that could total several hundred dollars.

Another word to the wise: Watch out for low introductory rates, especially on revolving credit lines. Your loan rate may start at six percent, but four months later increase to 12 percent. The loan rate may be variable, based on the prime rate in the future. Many variable rate loans have no cap on how high the interest rate may go. As a general rule, consumers should avoid loans without caps or with caps higher than they can afford to pay, no matter how low the current rate may be

Don't go with a high loan-to-value product unless you understand the conditions fully. Lenders who let you borrow more than your house is worth may not be doing you a favor. Besides, it's wise to keep some equity freed up for emergencies.

Ask the necessary questions and exhibit healthy skepticism before making any financial decision. It's in your best interest, literally and figuratively.

"Putting Your Home on the Loan Line Is Risky Business," published by the federal Interagency Task Force on Fair Lending, warns that whether a home equity loan is for a home repair, bill consolidation or some other purpose, you should really shop around. Copies of the brochure are offered free through HUD. Write to the U.S. Department of Housing and Urban Development, 451 Seventh St. SW, Washington, D.C. 20410 or call 202-708-3151.

Contact your Johnson Bank personal banker for more information.

Member FDIC