Q. At long last, our house is free and clear. We have a home equity line of credit of $75,000, and the interest rate is somewhere in the neighborhood of 6 percent. We itemize tax deductions and our federal tax rate is 39%.

We are several years away from retirement, and are considering using the home equity loan for investment. We would like to use $50,000 of the home equity line of credit and invest it in a growth stock for the next five years. Our accountant/tax advisor is strongly in favor of having an unencumbered house especially as we are close to retirement. Any suggestions?

A. It is my strong belief that homeowners -- of any age -- should make use of the equity they have in their real estate investments. As this column has suggested in the past, there are too many retired persons who are "house rich and cash poor." Hopefully, your house will appreciate in the future – perhaps not as dramatic as it did in the past two years – and this appreciation will continue regardless of the amount of equity in your house. Thus, for all practical purposes, that equity is "dead equity."

Although you state that your home is “free and clear”, actually, it is not. Your home equity is a trust (mortgage) recorded against your property, and thus you owe the bank whatever amount of money you have drawn on that equity loan thus far.

You have raised a number of sub-questions, all of which must be answered before you can make an informed decision as to whether -- and how -- you can spend this additional money.

First: should you use the equity in your home for investment purposes? My answer is a qualified yes. Are you prepared to lose your investment if the stock market tumbles? Growth stocks may grow -- or they may not. If you are in any way concerned about risk, you should consider investing in government insured programs. Obviously, the higher the potential return will also carry a higher risk.

I am sure that readers will ask: why borrow money at 6 percent only to invest it in a security which has a 2 or 3 percent rate of return? Here, you have to do the numbers, and also look to your own future situation.

At first blush, it makes no sense to pay more interest than you are receiving from your investment -- especially if that investment has no (or little) growth capacity. But there is one important factor that must be considered, namely the liquidity of your investments. If you find at a later date that you need money for emergency purposes, it may be difficult -- if not impossible -- to tap into the equity of your home when you are no longer employed. The investments you are considering -- whether stocks, mutual funds, or government securities -- do have -- or should have -- immediate liquidity.

Second. If you have decided to invest the equity in your home, what is the best route to take? You have indicated that your current home equity line of credit is around 6 percent. This seems about right in today’s market economy.

Many home equity loans fluctuate in rate; the rate of interest is often pegged to some index -- such as "prime rate". If the prime rate rises or falls, so will the interest rate on your home equity loan.

Instead of using your home equity, you might want to consider refinancing your home, while interest rates are extremely low. You can probably get a fixed 30 year rate for around 5 percent. While I understand that you may be reluctant to borrow for such a long time -- especially when faced with retirement -- the alternative is either to do nothing, or use your home equity loan where the interest rates may fluctuate over the next several years.

Third: How will you make the monthly mortgage payments when you are retired? If you do not have other sources of income -- such as a pension plan -- you still have the liquidity of your investments that should be able to carry you for a long period of time.

Additionally, if you decide to refinance your home, you definitely should keep the home equity loan available. As you know, a home equity loan is a line of credit; you only pay interest on the amount of the money you have actually borrowed. I like to make the analogy to a checkbook in your desk drawer; its there if and when you ever need it.

If you decide to refinance, make sure that you can also keep the existing home equity loan, or get a new one.. There are some logistical legal issues that your attorney can handle to make these arrangements.

Fourth. You must understand the tax implications of borrowing on your home equity. Interest deductions for tax purposes are based, in part, on what the IRS calls "acquisition indebtedness." In your case, this indebtedness is zero, since your house is free and clear of any first mortgage loan.. You will only be entitled to deduct interest on the first $100,000 that you borrow -- whether this money comes from a new first mortgage or a home equity loan.

It used to be that you could only deduct the interest you pay on your home equity loan under certain circumstances – such as for educational or health related purposes. Now, however, there are no limitations on what you can buy or invest with your home equity loan. In fact, according to the IRS, even if you borrow more than the $100,000, “if the proceeds of the loan were used for investment, business or other deductible purposes, the interest may be deductible.” (IRS Publication 936, entitled Home Mortgage Interest Deduction. This publication – as well as many other helpful consumer tax guides – can be found on the IRS’s website at www.irs.gov).

These are difficult -- and clearly personal -- decisions that everyone must consider. Talk to your tax advisors, and "crunch the numbers." You have a valuable asset in your home. While you obviously do not want to lose that home, you also do not want your equity to lie dormant.

Published: May 26, 2003

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Author of the weekly Housing Counsel column with The Washington Post for nearly 30 years, Benny Kass is the senior partner with the Washington, DC law firm of Kass, Mitek & Kass, PLLC and a specialist in such real estate legal areas as commercial and residential financing, closings, foreclosures and workouts. Mr. Kass is a Charter Member of the College of Community Association Attorneys, and has written extensively about community association issues. In addition, he is a life member of the National Conference of Commissioners on Uniform State Laws. In this capacity, he has been involved in the development of almost all of the Commission’s real estate laws, including the Uniform Common Interest Ownership Act which has been adopted in many states.