Realty Times June 3, 2002

Home Equity Loans Still a Bargain
by Henry Savage

Question: We've been living in our current home for six years. The house is 40 years old and we have finally made all the improvements we have dreamed of. A new kitchen, a new master bathroom and a new front porch. We paid nearly $50,000 in cash and now I'm wondering whether we should have borrowed the money. Our house is worth about $400,000 and the balance of our loan is about $200,000. Was it foolish of us to pay cash when we have so much equity?

Answer: In my view, it's never "foolish" to pay cash for anything. What's wrong with having no debt? Absolutely nothing. If you are highly in debt and you're paying double digit interest rates, you can get yourself in trouble. But if you use debt wisely as a leveraging tool, debt can be a good and useful thing.

Let's get back to your question. Was it foolish to pay cash for $50,000 in home improvements. No, but there may be a better way to do it. Allow me to make a few points.

  • Interest rates on home equity loans are very attractive. There are many lenders offering a home equity line of credit (HELOC) at prime rate, which is sitting at 4.75 percent -- real cheap. Now is not a bad time to borrow extra money against your home.

  • You have $200,000 in equity in your home. That's a lot of money and as long as your current and future income can support the extra monthly obligation, taking out a $50,000 HELOC isn't a bad idea. You still have $150,000 in equity left over.

  • Mortgage interest is tax deductible. This means the true cost of the equity line will be less that 4.75 percent, as long as the prime rate stays down. Having said these things, you should now ask yourself a few questions:

  • Do you have any consumer debt? Consumer debt, such as credit cards, often carries a higher interest rate and the interest is not deductible. If so, you'd be better off to transfer this debt to a HELOC because it's a much cheaper source of funds.

  • What's the rate on your current mortgage? If you're paying more than 7.25 percent, explore a cash-out refinance. You should be able to refinance to a lower rate with little or no closing costs. Your rate would drop and you'd get your $50,000 back.

  • Can you afford an extra mortgage payment? Expect to pay between $200 and $500 extra each month, depending upon how quickly you'd like to pay it off.

  • Do you have a disciplined savings plan? If not, it's wise to put away some money every month. At the very least, you should contribute to a tax deferred retirement fund.

    After you've answered these questions, you should be able to have a clearer answer as to whether or not it makes sense to pull some equity out of your home. As I said, the prime rate is at 4.75 percent -- hard to beat. Granted, the Federal Reserve will start raising rates eventually, but it has a long way to go before HELOCs start getting expensive. Consider this: Fed Chairman Alan Greenspan would have to have to raise short term rates by ¼ percent 12 times before the prime rate hits 7.75 percent.

    He probably will -- eventually. But in the meantime thousands of homeowners are borrowing money at a tax deductible 4.75 percent.


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