JANE BRYANT QUINN
Here's a question I put to a number of consumer-loan specialists last week: Is there ever a good reason for taking a home-equity loan worth more than your home?
Their various answers can be summed up in two words: "almost never." Still, there are some situations where the loan might be the better of two bad alternatives.
In the good old days (three years ago), lenders rarely permitted home-equity loans to exceed 80 percent or 85 percent of the value of your home, when combined with your first mortgage or deed of trust. A very few banks did 100 percent loans.
But finance companies (including those owned by banks) have gotten much more aggressive. They're peppering the country with ads for 125 percent home-equity loans, for people with good credit histories. Some lend up to 150 percent.
These are good-times loans, says Keith Gumbinger of HSH Associates in Butler, N.J., which tracks mortgage interest rates. The lenders assume that you won't lose your job.
Strictly speaking, you're not getting a true home-equity loan. The portion of the loan that exceeds the value of your house amounts to unsecured consumer credit.
The interest rate on a true home-equity loan is currently in the 8.5 percent range at big banks, says Robert Heady, publisher of the Bank Rate Monitor in North Palm Beach, Fla., which surveys bank interest rates.
The rate on loans larger than the value of your home is running at 13 percent to 14 percent, Heady told my associate, Kate O'Brien Ahlers.
Interest is generally tax deductible on home-equity loans of $100,000 or less. So borrowers assume that their full interest cost can be written off.
But not in this case. You can't deduct interest on the portion of your loan that exceeds your home's fair market value.
As an example, say you have a $200,000 home, with a $170,000 first mortgage and a $50,000 home-equity loan. You first deduct the interest on your original mortgage or deed of trust. Then you deduct the interest on $30,000 of your home-equity loan.
The rest of the interest is generally non-deductible unless the loan is used for a deductible purpose for example, to start a business.
There's a gray area here. Exactly what is your home's fair market value? You can take a stab at a reasonable valuation or get the opinion of a real estate agent. Whatever you decide will have to be defensible in an audit.
These big loans generally appeal to people with low home equity and huge credit-card debts, on which they're paying interest rates of 18 percent to 21 percent.
As a first step, you should try to transfer this debt to lower-rate credit cards. If that fails, and you opt for a big home-equity loan, you'll get lower payments, stretched over 20 or 25 years.
But what if you lose your job? In a crisis, you can quit paying credit-card debt and take the hit on your credit report. But if you quit paying your home-equity loan, you could be foreclosed.
What if you got a new job in another town? You can't sell your house unless you can repay the excess home-equity loan. And you can't generally buy a new house without putting at least 5 percent down.
What if you want to refinance the loan at a lower interest rate? No go, until you've got equity again, which could take 10 years or more.
What if you're middle aged? The cheapest way to live in retirement is in a paid-up home. You can't afford to strip yourself of equity.
What if you can't control your spending? Once your credit cards are clean, you might go out and charge again. You'd be better off struggling with the debt you already have and leaving your home equity alone.
What if you wind up in bankruptcy? Most credit-card debt can be dismissed, but generally not mortgages or home-equity loans.
The only people who might reasonably consider a 125 percent home-equity loan are those who: (1) managed credit reasonably well in the past; (2) are suddenly overwhelmed by a financial catastrophe, like uninsured medical bills or other unavoidable expenses; (3) have concluded that bankruptcy isn't an option; (4) won't run up other debt; and (5) will pay off the loan ahead of time.
Pay attention to fees
What's all this fuss about the fees people pay for their 401(k)s or, for that matter, their mutual funds or brokerage accounts? The U.S. Department of Labor is investigating 401(k)s, on a suspicion that the fees in some plans are unreasonably high.
Writers like me say you shouldn't pay more than 1 percent, and preferably less. But you might be saying, "Why should I care if I pay 2 percent or even 3 percent?" That seems a small charge for money management, account monitoring and administration. Why quibble about an itty-bitty percentage point or two?
But that percentage point is costing you more than you think. The percentage is low because it's charged against all the assets you have in the plan or mutual fund. But if you take the dollar fee and compare it with the profits you've earned, the percentage cost can be high indeed.
In a portfolio balanced between stocks and bonds, the fee could easily eat up one-quarter to one-half of your investment gains.
As an example, take an account of $10,000, for which you pay 2.5 percent a year. If the size of that account increases by 15 percent ($1,500), you'll pay $269 (the fee is assessed on average daily assets for the year, not year-end assessed). That eats up 17.9 percent of your profits, according to the Vanguard Group in Valley Forge, Pa.
If your investments gain 10 percent ($1,000), you'll pay $263. That takes 26.3 percent of your profits.
If your account gains just 5 percent ($500), you'll pay $258. That eliminates more than half of your profits. At this level, the fee can only be called confiscatory.
Compare these results with 401(k)s or mutual funds that take only 0.5 percent annually from your total account.
When your investment gain is 15 percent, the fee costs just 3.6 percent of the profits you've earned. On a 10 percent gain, you pay 5.3 percent of profits. On a 5 percent gain, you pay 10.2 percent of profits.
That's a huge difference when compounded over time. During the years you participate in a 401(k), the high fees that some plans charge especially small plans could cost you an amazing $100,000 to $200,000 more than you'd pay in a low-fee plan.
Syndicated columnist Jane Bryant Quinn can be reached in care of the Washington Post Writers Group, 1150 15th St., Washington D.C. 20071-9200.
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