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Financial Planning > College Planning > Student Loan Debt

Priming The Home Equity Pump

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By Jim Connolly

With the prime rate at an all-time low of 4%, current rates for home equity loans and lines of credit are now so advantageous that many planners are fielding questions from clients about the loans.

Rates have been so attractive that “we have been using them a lot more in the past 12 months,” says Diane Pearson, director of financial planning with Legend Financial Advisors Inc., Pittsburgh. “We absolutely recommend them.”

A spot search on the Internet on April 19 confirmed the favorable market environment.

Assuming a scenario in which a home is worth $400,000 and the first mortgage balance is $100,000, here are some rates that turned up.

In one case, a home equity line of credit (HELOC), with an 80% loan-to-value ratio, offered a variable rate of 6.4% for loans of up to $25,000; 4% for loans of up to $75,000; and 3.75% for loans of up to $220,000. For a 90% loan-to-value ratio, a loan of up to $250,000 was fetching a rate of 5.50%.

Given the same scenario, but using a fixed rate home equity loan instead of a HELOC, an 80% loan-to-value ratio offered for loans up to $25,000 was 9%; 6.74% for loans up to $75,000; 6.25% for loans up to $220,000; and, for loans of $250,000 with a loan-to-value ratio of 90%, a rate of 7.25%.

Pearson says that the variable rate of a HELOC makes more sense if a client plans to pay back the loan in 7 rather than 10 years.

The choice between a HELOC and a home equity loan depends on whether the money is for a specific project or an ongoing need, and on the clients cash flow capabilities, Pearson adds.

Since a HELOC offers a variable rate, an advisor must be sure that a client understands that the rate can change, she says.

Clients are using home equity loans for many purposes including purchasing second homes in warmer climates and college for children, says Lee A. Spadoni, a certified financial planner with Horizon Financial Planning, LLC, Naperville, Ill.

Using home equity can be a “good idea” for emergency funds or if assets are illiquid, she continues. It can be a bad idea if someone has “credit issues” and treats it like “one great, big credit card.”

If a fixed rate home equity loan is chosen, there will be a higher rate because of the lock-in to that rate, she continues.

Even so, “the prime is so low, it is a great option,” Spadoni says. Still, you “dont want to tell them to go to town.”

Bedda Emous, a managing director with Fiduciary Solutions, North Andover, Mass., says that by and large, her baby boomer clients have paid off their mortgages on their primary residences and may have a small mortgage balance on a second home.

But, she continues, she does not usually recommend them. “Im very traditional. I dont believe in debt. I dont believe in home equity loans. I just dont recommend it.”

Even for younger boomers, she prefers to find the money through a rigorous cash flow analysis.

If a client is in a difficult situation such as pending unemployment or college tuition costs that cannot be funded through savings, she says use of home equity can be considered. But barring such events, Emous continues, “The worst thing is a credit card. Home equity loans are the second.”

Reproduced from National Underwriter Edition, April 23, 2004. Copyright 2004 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.


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