For home equity loans, it's a buyer's market

Nation's Business, May, 1991 by Peter Weaver

For Home-Equity Loans, It's A Buyer's Market In parts of the country where lenders face plenty of competition, banks and savings institutions are offering home-equity-loan "sales."

"It's a buyer's market"--that is, a borrower's market--says Steve Skalet, a real-estate attorney in Washington, D.C.

"Some lenders are offering home-equity lines of credit with no closing costs, no fees whatsoever," to qualified borrowers, he says. Other lenders are countering with lower rates, such as one point above prime (the best rate given to big corporate borrowers) plus rebates on closing costs, depending on how much you borrow during the year.

"With rates at their lowest point in several years," Skalet says, "some homeowners are refinancing their first mortgage and getting a special deal on being able to combine a home-equity loan in the same package." Here's how it works:

Let's say you originally purchased your home for $100,000 and it is now appraised at $200,000. Your mortgage has been paid down to $75,000. Lenders will usually let you borrow up to 80 percent of the current appraised value of the home. In this case, it would be $160,000 (80 percent of $200,000).

Until recently, the Internal Revenue Service said that when you refinanced a mortgage on a home that had appreciated in value, you could only get a tax deduction on interest paid for the amount of the existing loan. In this case, the limit would be $75,000.

If you wanted to refinance up to the full $160,000 allowed by the lender, $85,000 of the $160,000 would not qualify for an interest-based tax deduction.

To get around this, homeowners who wanted the full tax deduction had to refinance their existing mortgage at the lower rate and then go out and get the remainder financed with a separate home-equity loan.

The home-equity loans, in these transactions, incurred additional closing costs, were at higher, floating rates, and didn't have the optimum, 30-year-amortization terms enjoyed by first-mortgage holders.

"So the IRS relented," Skalet says, "and has now ruled that you can combine refinancing your first mortgage with a home-equity loan in the same package."

The whole thing looks like a first mortgage and acts like a first mortgage, but the IRS says you can call one segment a home-equity loan in order to qualify for the tax deduction without all the fuss and cost of getting a separate home-equity loan.

There is a limit on how much of your home-equity portion can qualify for the interest deduction. The IRS says it can't exceed $100,000, except in cases where it's used to pay for home improvements.

Homeowners who don't need to borrow the full amount available can stick with the first mortgage they have, or refinance it at a lower rate, and get a home-equity line of credit on the side.

Having a line of credit, as opposed to getting a home-equity loan through refinancing the first mortgage, gives you the advantage of only paying interest on what you borrow, when you borrow it.

According to Larry Magnesen, national product manager for Citibank, "People are using their home-equity money for home improvements, college expenses, and paying off high-interest credit-card debt, where there's no longer any tax deduction."