f you're a homeowner, chances are you've been hearing a lot about home equity loans and lines of credit. Ads flash across your TV screen. Direct-mail fliers land in your mailbox. The message is that you can use a portion of the equity in your home—that is, the difference between your home's value and your outstanding mortgage liens—to borrow for other items you need or want. As a result of all this attention, old attitudes surrounding home equity loans are vanishing.

"Remember when they were called second mortgages?" asks Carmen Allenbrandt, lending product manager at ESL Federal Credit Union in Rochester, N.Y. "They used to be considered the last resort (for borrowing). Now people talk about their equity lines at parties. It shows you're savvy about how to manage money."

Kerry Goodliffe Parry, marketing manager at IBM Rocky Mountain Employees Federal Credit Union in Boulder, Colo., agrees that consumers are more comfortable today about borrowing against their home equity. "They're good borrowers and always have been," Parry says. "So why would they become reckless with their most prized possession: their home? ... People are realizing that the equity in their homes is an asset to them, and they can borrow against it."

    If you're applying
    for a home equity loan,
    you might as well apply
    for a line of credit
    at the same time.

Tax breaks a big plus
One reason home equity loans and lines of credit make good financial sense is because of the tax deductions usually available. Your tax adviser can help you determine if you're eligible for such deductions. And the people at Pacific Community credit union can tell you more about your home equity borrowing options. Overall, they fall into two categories:
  • Home equity loans are for a lump sum you borrow at a variable or fixed interest rate. Fixed-rate loans are the most common. You must repay the loan within a set period, which might range from five years to 30 years.

  • Home equity lines of credit are open credit lines you can draw on as needed, up to a preset credit limit. Usually the line has a variable interest rate tied to some sort of index, such as the prime rate. As you pay off what you owe, you replenish your credit line up to your credit limit.
Which type is best for which use? "That depends on what you're going to use the money for," Allenbrandt says, "and how you like to manage your personal finances. If you're risk-averse and need the stability of a fixed payment, a home equity loan is a better fit."

These days consumers are using either loans or credit lines to pay for home improvements, still the No. 1 reason for home equity borrowing at her credit union, Allenbrandt says. While the loan gives the borrower the needed sum to pay for, say, adding a new bedroom, "many people take out a home equity line because they like the flexibility," she notes. "They get the cash they need up front, but then they have the flexibility of using that line to pay for furnishings for that room or other subsequent purchases."

Finance your auto
Even if you see no needs now for future borrowing, if you're applying for a home equity loan, you might as well apply for a line of credit at the same time, advises Parry. You're already filling out the paperwork and it won't cost anything extra in fees, should there be any, to apply for the credit line, too.

"Say you have $30,000 in equity," Parry explains, "and you're going to spend $10,000 to build a deck. You could go ahead and get the $10,000 loan, and also get a $20,000 line at the same time. Then when you need money for a new car two years down the road, you'll be set. You can write a check for it."

Car purchases are a key use for home equity borrowing among her credit union members, Parry says. Still, many people think car purchases and regular car loans have to go together. "It's surprising that a lot of people will already have a home equity line and they'll come in to borrow to buy a car," Parry says. "I ask, �Why would you want an auto loan when you already have the home equity line of credit?' They say, �Oh yeah.� It doesn't take a lot of prodding, just a little reminding."

But aren't auto loan rates the same or maybe even lower than home equity loans or lines? Sure. But you still may save by going the latter route. This gets back to the benefits of tax deductibility. Say the home equity loan or line carries a 7.75% interest rate. If you're in the 28% tax bracket, that means you can think of that 7.75% rate as being 28% lower—in other words, 5.58%. You'd be hard-pressed to find an auto loan rate to match or beat that.

"One thing I find is that people often don't think in terms of what the after-tax rate is," Allenbrandt says. "They see the (home equity loan or line) rate on the page and they think, �That's pretty reasonable.' But once I show them what the after-tax equivalent is, they get real excited."
    People are realizing that
    the equity in their homes
    is an asset, and they can
    borrow against it.

Many people take out
a home equity line
because they like
the flexibility.
Consolidate your debts
Another major use of home equity loans and lines is for debt consolidation. Paying on various loans and credit cards can total up to a bigger monthly amount due than if you pooled all that debt into one loan, with one rate and one monthly payment. "That frees up cash flow," Allenbrandt explains. Plus, you get the added benefit of tax deductibility on the interest.

One caveat for those who pursue debt consolidation: This strategy can help you if, for example, you've plunged too deep into credit card debt. But those card offers will keep coming your way. If you bite on those offers and return to your old card use habits, you'll end up back where you started before consolidating your debts. And now your home is on the line, too.

While home improvements, auto purchases, and debt consolidation are the three major uses of home equity loans and lines that Allenbrandt and Parry see at their credit unions, the possibilities don't stop there. You can use home equity lending products to finance a business start-up, pay for a wedding, cover college costs, fund a vacation, meet an unexpected financial emergency, and more. And with the home equity line of credit, you have the added advantage of having the line available to you, immediately, up to your credit limit, without having to reapply for a loan each time you need funds.

Home equity borrowing "is one of the smartest ways to borrow," Parry says. "If you're going to borrow money, why not take advantage of the tax benefits that go along with home equity loans and lines? It just makes sense."

©1999 Credit Union National Association Inc.