New twist on borrowing -- getting credit on the equity in your home
Americans have borrowed more than $340 billion in installment debt. And a host of companies are looking for ways to lend them more. The newest wrinkle in consumer lending offers a novel way for homeowners to borrow against the equity in their homes.
Under the plan, being pushed by several consumer finance companies and brokerage houses, a homeowner is given a line of credit based on the equity he has in his house. Then whenever he wants to spend the money, it can be tapped using a check or bank credit card.
''This provides you with one-step credit management,'' asserts Michael Johnston, president of Merrill Lynch Equity Management. ''It is large enough to meet all your credit needs.'' The minimum credit line is $10,000, but many are larger. ''We have some lines for $2 million,'' he says.
For years, homeowners have been able to make second mortgages on their houses. After paying expensive start-up costs, monthly payments start right away.
Under the Merrill Lynch ''Equity Access'' plan, and others like it offered by Shearson/American Express and Beneficial Corporation, a borrower applies for a line of credit based on his home equity. When the credit line is granted, Merrill places a lien on the house and charges a one-time fee of 2 percent of the credit line. So on the minimum $10,000 credit line, the fee would be $200, plus a $35 application fee.
Unlike a second mortgage, there are no other charges until the line is used. In addition, the interest rate, 2 percent over the prime rate, is well below that for most second mortgages. And in contrast to second mortgages, an individual can pay only interest after funds are borrowed, repaying principal at the end of 10 years when the credit line expires.
An estimated $3 billion in credit has been applied for at Merrill Lynch, Mr. Johnston says. The company offers the product in California, Arizona, Oregon, Connecticut, Georgia, Virginia, and North Carolina. ''We have plans to go into six or seven more states'' this year, he says.
Still, there are more traditional ways to borrow money.
In general, credit is cheapest when a borrower pledges some form of security like a home, car, or savings passbook. ''The least expensive credit would be where (the lender) has some security on it,'' says Sheldon Golub, a spokesman for the American Bankers Association.
The most common forms of secured borrowing include:
* Passbook loans. In such a loan you agree to leave a portion of your savings on deposit as security for the loan. In return, passbook loans typically carry an interest rate a few points above what you earn on the savings account and below the rate charged on other loans. The typical passbook now pays an interest rate of 5.5 percent.
Experts note that the interest rate on the loan is not the difference between the loan charge and the rate earned on the savings. The savings rate is irrelevant to the cost of the loan. Neither NOW (negotiable order of withdrawl) accounts nor IRAs (individual retirement accounts) can be pledged as collateral for a loan.
* Life insurance loans. The cash value of a whole life insurance policy can be pledged as collateral as a loan from an insurer. Typically, you can borrow up to 95 percent of the cash value of the policy on demand. The loan need never be repaid, but if the policy holder passes on while the loan is outstanding, the payment to the beneficiaries is reduced by the unpaid balance on the loan. The interest rate charged on loans is specified in the individual policy.
* Second mortgage. For amounts of $10,000 or more, ''the cheapest option in the long run is a (second) home mortgage,'' says Richard Miller, a partner in the Los Angeles office of the accounting firm Peat, Marwick, Mitchell & Co.
In general, you can borrow up to 80 or 85 percent of your home equity, according to the book ''Where to Get Money for Everything,'' by Paula Nelson (William Morrow & Co.). Rates vary, but currently range from 121/2 to 16 percent.
Unsecured personal loans are issued on the basis of the size and regularity of your paycheck as well as the strength of your credit references. In most cases, unsecured loans are available only up to a few thousand dollars and are fairly costly. Two of unsecured borrowing options are:
* Bank signature loans. You sign a promise to repay the loan. Credit standards are high, and loan requests for under $1,000 are usually rejected with the suggestion that the funds be borrowed on a credit card. Rates are about 17.6 percent.
* Bank credit cards can be used for a cash advance up to the amount of the credit limit merely by filling out some simple paper work. Rates average 18.89 percent.