Equity express home loan mortgage

Commentary: Don't abuse your home equity loan

During these tough times, many Americans are dealing with complex financial challenges such as unemployment, high credit card debt, overwhelming expenses and the struggle to save for long-term goals and retirement. It has become more tempting than ever to tap into what is likely your biggest asset, your home.

After more than a dozen interest rate cuts from the Federal Reserve over the past year, the cost of borrowing money against the equity in your home has become considerably cheaper and is often tax deductible.

However, when using your home for borrowing needs, you need to be aware of the responsibilities of choosing either a home equity loan (HEL) or home equity line of credit (HELOC). Before deciding what's right for you, know your options and the possible risks involved.

Know the products

One option is a HEL, which is essentially a second mortgage with a fixed interest rate that is locked in when you secure the loan. With a HEL, you receive a lump sum of money and pay it back in fixed monthly installments over a specified period of time, typically 10 to15 years. A HEL is best used for a one-time goal that requires payment due in full and that has long-lasting benefits, such as paying off high-interest credit card debt or funding a one-time home improvement that boosts the equity in your house.

Another choice is a HELOC, which functions more like a credit card with an assigned credit limit. According to the Consumer Bankers Association, the average credit limit for new home equity lines is $55,307, which is slightly lower than last year's average of $58,832. Whenever you use some of the credit, you owe a minimum monthly payment on your outstanding balance. A HELOC gives you repayment flexibility because you determine how much you pay back and when.

However, the HELOC interest rate is variable, averaging 1 percent over prime rate, the rate at which banks lend to their most creditworthy customers. A HELOC may be a good choice, for example, if you have a multiyear home improvement project for which you will have to write checks at various times. However, HELOCs are a great choice when interest rates are very low but tend to be more risky than HELs in an increasing rate environment.

There are many criteria for determining if a loan or line of credit is the right tool for you. However, if you are considering a HEL or HELOC for the tax break, make sure you understand the actual benefits.

The interest deduction is only a percentage, not a dollar-for-dollar reduction of your taxes. With the tax rates declining, the deduction may lose its appeal. Furthermore, if your gross income is high, the phaseout for itemized deductions may kick in, preventing you from taking a full deduction, if you get any at all.

Know your options

As attractive as a HEL or HELOC may seem, you must first ask yourself if you should be tapping into your home equity at all.

Home loans in foreclosure edged up to a record level at the end of 2002, as a weak economy and job market forced a larger portion of mortgage holders out of their homes. According to the Mortgage Bankers Association of America, foreclosures grew to 1.18 percent of all mortgages in the fourth quarter from 1.15 percent in the third quarter 2002.

The bottom line is that if you can't make your required monthly payments, you put your home at risk of foreclosure. If you are taking out a loan or line of credit to help pay for years of living above your means and you haven't taken control of your spending, you shouldn't put your home at risk.

Consumers should understand all of their options when deciding to borrow money. Cash-out refinancing of an existing mortgage is one such option. If your property has appreciated in value and there is equity in your home, you can increase your existing mortgage and refinance the rate of the new loan. By doing this, you can lower your rate and monthly payments, and you will receive the difference between your old and new mortgage in a lump sum.

Before you take out equity loans, you should also consider no- closing-cost refinancings. With these loans, the lender pays the closing costs and charges a slightly higher interest rate. Under some circumstances, this can result in lower monthly payments than if you roll the closing costs into the loan at a slightly lower rate.

Home owners with less-than-perfect credit should be even more cautious. According to the Mortgage Bankers Association of America, the number of subprime loans made to borrowers with less-than-perfect credit has grown in recent yeas as lenders expanded their markets. These higher- cost loans also carry a higher risk of default for both the consumer and the lender.

No matter what your financial situation is, or which product you are interested in, be sure to consult a qualified financial advisor before taking action.

If you have any questions about this information, contact Dena Shapiro Frenkel, American Express Financial Advisors at 410-664-5480 or dena.s.frenkel@aexp.com. She is also available for an educational workshop for your business or organization.