Tom Kelly: Home-equity loans come in different forms

Twenty years ago, the dreaded second mortgage was typically reserved for an unpredictable disaster or an underestimated necessity. But bolstered by the easier access to cash and possible tax advantages, consumers now are using second mortgages, commonly called home-equity loans, to finance cars, campers and real estate.

The subject of needed “quick bucks” surfaced again recently when a reader emailed about purchasing the raw land directly adjacent to her home. The land was headed to foreclosure and the woman wanted to know if she could get a home-equity loan fast enough to buy the land at the foreclosure sale.

It was not an unfamiliar question. Not only are most home-equity loans relatively inexpensive and easy to obtain, but the process is also much faster than a standard first mortgage. In fact, many foreclosure-property regulars who peruse the legal notices looking for bargains then show up on the courthouse steps (or other public places) use revolving lines of equity credit to purchase their investments.

Homeowners can deduct interest on loans made against the value of their homes – up to the original purchase price of the house plus $100,000. And, because interest on consumer loans or credit cards is no longer deductible, borrowing against the house to pay off high-rate consumer debt has become extremely popular.

The loans have given lenders the incentive to smooth over the unpleasant connotations of “second mortgage” and create a new atmosphere surrounding “home equity.”

Home-equity or line-of-credit loans have many different labels (Lifeline, Advance Line) to lure borrowers to particular plans. All of the programs are legal documents and are commonly known as second mortgages. A second mortgage takes second place to the first mortgage at the time of foreclosure. In case of default, the first mortgage has priority of claim over the second.

The most popular variation of the second mortgage is the now common home-equity loan in which the loan is secured by a deed of trust. The home’s value is determined by a tax assessment or by an independent appraisal.

A home-equity loan can be a lump sum or a line of credit that can be drawn on with a check or credit card. The typical home-equity second mortgage now being offered is secured by the additional equity accumulated in a principal residence over and above the first mortgage debt.

Interest rates vary, with equity lines of credit about half a percentage point greater than a lump sum, according to Bankrate.com.

A $350,000 house with $200,000 owing on the first mortgage has a net equity of $150,000. Most local lenders allow borrowers to bring total home debt to 80 percent of the total resale value, in this example, 80 percent of $350,000 equals $280,000. Subtract the amount owing on the first mortgage – the $200,000 – and that leaves $80,000 in equity that can be borrowed.

Lump sum or line of credit? Good question. If taking out an $80,000 home equity line of credit at 5 percent, amortized over 15 years, the monthly payment would be about $632.63 The same amount in a lump-sum home equity loan at 4.5 percent over 15 years would be about $611.99 per month.

The drawbacks of home-equity loans hit close to home because that’s exactly what is held hostage if the debt is not repaid. If rates rise and the borrower is saddled with an unexpected problem – such as loss of a job or a divorce – that means not being able to pay, the lender could foreclose and eventually take the house.

One rule of thumb is that anything you buy and use immediately – food, entertainment, fuel – should be paid for out of current income. The convenience of writing your own check for any purchase against a loan can spark the frivolous in many consumers. In fact, some financial advisers say abusers of credit may be smart to stick with car and boat loans. That way, they aren’t risking the roof over their head if they can’t afford the payments.