How to Spend Your Home Equity Loan

Q.: I've been having a debate with my wonderful wife. We owe $10,000 on a home equity line of credit and we have a car loan with a balance of about $16,000. I would like to borrow more from the home equity line to pay off the car loan since interest on the home equity loan interest is tax deductible. My wife would rather use some cash we have to pay off the home equity line and continue paying the car loan. She's uneasy about having a second mortgage on our home. We almost always see eye to eye on things financial, but here we disagree. What do you think is the best course?

- Adam, West Chester, Pennsylvania

A.: Normally, taking sides in a spousal dispute over finances (even if one of the parties is a "wonderful wife") is not a prudent course of action. But in this case it should be pretty easy to accommodate the needs of both parties.

First, it makes sense to effectively move the car-loan balance onto the home equity line of credit. You don't say what the respective rates on those loans are, but recent rates show that the rate on home equity lines of credit are as much as six-tenths of a percentage point lower than rates on new-car loans.

And that's before taking taxes into account. Most likely, you can deduct the interest on the home equity line, although there are some restrictions on deducting that interest.

Granted, home equity lines are typically tied to the prime rate, which means if interest rates rise, so will the rate on your loan. But unless rates really move up, it’s unlikely that the car loan will end up being less costly after taxes than the home equity line of credit.

Consider your overall debt load

Now that you've got what you want, let's move on to your better half's concerns. It's admirable that your wife is wary about loading up the old homestead with debt. Too many people today view their homes as money machines to fund a lifestyle they can't afford.

To assuage her apprehensions, you can always take some of that cash you mentioned you have available and use it to pay off part of your home equity loan. In fact, if you followed your wife's original plan to pay off the original $10,000 balance with that cash, you would be left with home equity line balance of $16,000.

Yes, that would be $6,000 more in home equity debt than you had before. But the amount you owe overall would have declined from $26,000 to $16,000 - and the savings on that $16,000 would be fairly substantial given the home equity line's lower rate and the tax write-off.

In fact, maybe you could offer your wife this further concession: In addition to making regular payments to pay the home equity line, how about if you increase the payments to reflect the tax savings? This way, you'll get rid of the home equity debt even quicker.

One caution, however. Some people pay off auto or credit-card loans by moving them to a home equity line, and then go right back and take out another auto loan or run up their credit-card debt again. In short, the whole "transferring the debt to save interest expense" premise turns out to be nothing more than a rationale to do more borrowing.

But it doesn’t appear that is going to happen in your case. Why? Well, you seem like a pretty sensible guy. And besides, your wonderful wife wouldn’t allow it.

Bob Roscoe, Mortgage Marketing Associates, Minneapolis, Minnesota
Loan Secrets