The Wall Street Journal Online
April 15, 2004

U.S. Consumers Turn to Home-Equity Loans As Rates Head Up

NEW YORK-Home-equity loans have become an attractive option for consumers looking to tap into the value of their homes, but with interest rates on the rise, this source of cheap cash bears its own pitfalls.

That's because home-equity lines of credit are tied to the prime rate, which in turn is linked to the federal funds rate, the Federal Reserve's key interest-rate target. And with the economy recently turning in a stronger performance, expectations are that the fed funds target rate could be heading higher soon - as early as August, say some.

"It's very dangerous to make long-term borrowing decisions based on short-term interest rates," said Gary Schatsky, a financial advisor and former chairman of the National Association of Personal Financial Advisors. "If you are taking one of these (home-equity loans) out with long-term interests in mind, you're making a big mistake, because rates are only headed higher, and so your payments will be too," he said.

Fixed mortgage rates have risen sharply, as the stronger economy has fueled a rise in treasury yields. That's pulled the rug out from under refinancing activity, which was one way many homeowners accessed the equity in their homes.

The prime rate, in contrast, has been steady at 4.00% ever since mid-last-year - making home equity loans an attractive alternative.

BORROWER BEWARE

Michael Moskowitz, president of Equity Now, a direct mortgage lender based in New York, said he is seeing a lot more interest in home-equity loans, but he doesn't recommend them to everybody.

"The home-equity product works great for people who have immediate or seasonal needs, such as college education or home repairs," he said. "They are fine for now, but borrowers should be careful, because the prime rate may shoot up, which will make the loan costlier."

"If you don't have short-term needs for cash, a fixed loan makes a lot more sense in this environment," said Moskowitz.

Equity Now has seen interest in home-equity loans jump 20% over the past few weeks. The company offers the loans at rates between 0.5 percentage point below to 1.5 percentage points above the prime rate, or between 3.5% and 5.5%.

The rate a consumer receives is based on several variables, including credit history, loan-to-home value, and income.