STRATEGIES The New Money

NOW THAT HOME EQUITY LENDING IS A reality in Texas, we can all go about consuming inconspicuously and never have to worry about credit card debt, college tuition, or business startup costs again. Right?

Wrong.

Though the advertisements and business-media stories have described in detail many of the advantages of home equity loans, there are some benefits that haven’t been discussed. There are also some tips that might make you question the wisdom of borrowing against your home and a picky little tax matter that might stop higher-income folks in their tracks. And the future may hold some interesting occurrences as home equity lending becomes popular and part of the culture.

The bottom line is that home equity loans should be treated not as manna from heaven that will suddenly make all money worries go away, but as a part of an overall financial strategy.

“Before this, residences were treated as personal property, not as something available for building assets for future investments,” says Alan Goldfarb, certified financial planner and president of Financial Strategies Advisory Corp. “Now you have the option to use the equity in your house to fund other long-term considerations. It becomes part of the investment portfolio.”

As with any investment, people should use home equity loans wisely. With that in mind, here are 10 tips, advantages, disadvantages, and possible future effects of home equity loans.

WATCH YOUR STEP

Don’t use long-term money for short-term objectives. Think about this scenario: You takeout a 15-year home equity loan to start a business, and you buy a $10,000 computer system. That computer will become obsolete in three to five years. Meanwhile, you’re paying it off for another 10 to 12 years, and you still have to buy another, more up-to-date system. It is the Reunion Arena conundrum in miniature.

“The real gist is that people borrow very often for the wrong reasons,” says CPA Gerald Kepner. “They fail to match the expenditure with the length of the loan.”

The key, Kepner says, is to get a loan term that matches the desired benefit. Go with a short-term loan for credit card consolidation. “If you’re using it to start a business, you need to think about the length of time you need for the business to be successful. You ought to say, I need that computer to last me three years, and I need working capital to spend for the next six months,’ so you need to do some projections and match some expenditures.”

Todd Maclin, Dallas-Fort Worth area chairman and CEO of Chase Bank of Texas, sees it differently. “Home equity lending is the place to borrow money for the longer term,” he says, “which is the best approach to financing a new business.”

Look at other tending products. The law states you can have only one home equity loan outstanding at one time, and you can take out only one in a 12-month period. So don’t expect to take out $10,000 now to pay off Visa and another $10,000 in September for Junior’s college tuition.

Remember that banks offer other kinds of loans. “If you use a home equity loan to build a room addition to your house, and that’s all you’re going to need, that’s fine,” says Chuck Baynard, executive vice president for consumer banking at NationsBank Texas. “But you can get a home improvement loan [to build the addition], and that would be better because you don’t use your one (home equity loan] per year.”

Again, it depends on Goldfarb’s financial strategy. If you’re not going to need a loan for college tuition or entrepreneur-ship, it could be advantageous to use home equity for a car or a boat.

“That gives you a better rate and allows you to deduct interest,” Baynard says. Maclin sees another advantage: ’’You can extend the maturity of that debt. The typical car loan is five years; the typical home equity loan is of a longer duration.”

But what Maclin sees as an advantage, Kepner sees as a disadvantage. The middle ground is to make sure you have the car or the boat for the duration of the loan.

Not so fast on the tax deductions. Read the fine print in those home equity ads. When they talk about tax deductibility, try to spot the “may be” and “in many cases.” All of them suggest you talk to your tax adviser.

There’s good reason. In 1997, if you and your spouse made more than $121,200 jointly (1998 figures may be different), your itemized deductions-which include interest on a home equity loan-are reduced. The amount of that reduction: 3 percent of the income over that $ 121,200 or 80 percent of the itemized deductions otherwise allowable, whichever is less.

Kepner’s example: Suppose you make $150,000 and have $20,000 in itemized deductions. Add home equity interest payments of $ 1,000. Your income is $28,800 over the limit, so your home equity deduction would be reduced by $864. That means only $136 of that interest is deductible-not the entire amount.

On the other end, if your itemized deductions are less than the standard deduction-$6,900 for married filing jointly in 1997-and home equity interest wouldn’t put you above that mark, you won’t see any tax benefit from the new loan-only a lower interest rate.

Beware closing costs. In their initial push, the banks featured deals in which they would pay the closing costs for home equity loans, which can range from $400 to $750, depending on the amount and duration of the loan. But those offers won’t last forever. Vivian Pangburn, NationsBank Texas vice president of regional marketing, says all banks will “reassess” those offers after the initial promotion ends.

However, she adds, “closing costs as an offer are very much associated with home equity lending,” so it’s likely you can find a deal that will reduce, if not eliminate, those costs.

LITTLE-KNOWN BENEFITS

Dont fret the financial-aid crunch. Isn’t it amazing how academicians can sometimes make false assumptions? For some reason, they have determined that if you have a large house, you automatically have enough cash on hand to pay full tuition at your kid’s college. That’s why they include the value of your home when determining how much, if any, financial aid they’ll give your prodigious progeny.

That used to provide quite a dilemma. You can’t get a guaranteed student loan, and you couldn’t borrow against your home. Il didn’t leave much choice. Now you can borrow against the equity in your home, and it will cost you less in interest and can be deductible-so you can be safe in knowing that Junior won’t have to work part-time to pay tuition; he’ll be able to spend all his time in class or at the library.

Pay off the first mortgage. They’re offering home equity loans for as little as 7.75 percent interest. If your first mortgage balance is 40 percent or less of the appraised value, and your interest rate is above what you can get in a home equity loan, you might catch a break with a home equity loan. “It’s driven on the existing interest rate,” says NationsBank’s Baynard.

Why a 40 percent balance? If you get a home equity loan, the total lending secured by your home can’t exceed 80 percent of the home’s value. So, assuming you don’t want to keep any of the first mortgage on the books, you’ll need to borrow the entire amount.

Such a transaction can also help your tax situation. If your first mortgage balance is down to 40 percent of equity, you’re probably in your last 10 to 12 years of the mortgage-when the amount of principal paid each month skyrockets and the amount of interest paid plummets. The more interest you pay, the more you can deduct-even if you ’re above the $ 121,200 level.

More competition, or “The Battle of the Jock Endorsers.” What do Hall-of-Fame quarter-back Terry Bradshaw, Hall-of-Fame pitcher and underwear pitchman Jim Palmer, and over-the-hill boxer George Foreman have in common? They are all appearing or will appear in advertising for non-bank financing corporations that plan to aggressively compete for home equity loan business.

Irving-based The Associates has the home-field advantage and is using Bradshaw in its ads. Delaware-based Beneficial Finance runs ads featuring Foreman, and Sacramento-based The Money Store has built its image around Palmer.

All these institutions were loaning money to Texans before home equity loans were legalized, but they just weren’t visible. All provided personal loans and first mortgages, and The Money Store provided U.S. Small Business Association loans and student loans, according to senior vice president Jeff Rogers.

Fred Stern, senior vice president of The Associates, says that these non-bank fiSTRATEGIES

nance companies are a little more lenient when it comes to loan approval.

“Like the banks, we’ll look at current income and the equity in the home,” he says. “But we will also look at a person who has had credit difficulty or is self-employed or has recently gone through a divorce.”

For the self-employed, Stern says his loan officers want to see “some indicators of reliability of income.”

NationsBank’s Baynard isn’t fazed by the prospect of more competition. “It’s very competitive now,” he says. “The rate offering is strong. We have strong coverage in Texas; there are more outlets, more ways for people to talk to us. whether at stand-alone branches or supermarket branches or by phone, so the breadth of coverage is stronger than any other bank or lender in Texas.”

FUTURE EFFECTS

Watch for shorter mortgages, Financial planner Goldfarb says he expects a substantial increase in 15-year mortgages, instead of the traditional 30-year notes.

“We’re used to receiving the longest term with the least down payment.” Gold-farb says. “If you accelerate payment, it gives you that much more access to your equity that much sooner. That’s always been a viable alternative from a psychological standpoint; now it’s viable from a financial standpoint”

That, of course, is because of the way the mortgage charts work: You’re paying almost nothing but interest the first several years, and you won’t have any significant borrowable equity until halfway or more through a 30-year note. With a 15-year mortgage, you could be able to buy that boat or add on to your house in seven or eight years.

The legislative fight isn’t over. It took a century and a half for home equity lending to come to Texas, and it’s still the most restrictive such law in the country. The most inconvenient restriction is that only closed-end loans are permitted; bankers would like to see revolving lines of credit available.

’The facts are that these types of loans in states that have had them for years have lower default rates, and there is no evidence to suggest things will be any different in Texas,” says Chase’s Maclin. “We are trying to convince our client base to talk to legislators. We hope people will embrace our products, people won’t show any concern, and (he Legislature will allow the same flexibility that home equity borrowers in other states have.”

Under the line of credit, a borrower makes one application, receives one approval, takes out the money as needed, and pays it back as he can with a minimum every month. That way, a borrower could use $10,000 for tuition, pay it back, and use $10,000 for a computer 10 months later-without going through the application process again.

“As people get to understand home equity loans and see the advantages, I think they would want lines of credit, and I think the Legislature will respond to that,’’ Bay-nard says. “I think at some point that will happen; it’s anybody’s guess as to when.”

In other words, there’s still more legislative fireworks over home equity on the horizon. It’s never easy-just like the decision whether or not to get a home equity loan.