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If it looks like a credit card and acts like a credit card, is it taxed like a credit card? Not when it's a home equity line of credit.
But even as the loans are being promoted more and more like credit cards, there is talk among lenders and industry watchers that they might not remain tax deductible forever. After all, credit card interest lost its deductible status more than a decade ago.
Don't count on it
Experts say people who would shy away from the loans if they were not tax deductible should take the talk into account when making a decision to borrow.
"There's nothing at all that's stirring directly," says Fritz Elmendorf, a spokesman for the Consumer Bankers Association in Arlington, Va. But, "clearly home equity credit is largely a substitute for other types of credit, particularly when it's marketed very directly as a substitute.
"It does invite the question of tax deductibility."
There was a time
Legislators have repeatedly shifted position on consumer loan interest. It's hard for today's college students to imagine that just over 10 years ago, charging a sweater at the Gap could mean a tax deduction on April 15. But in the days of Boy George and Miami Vice, that was indeed the case.
"Through 1986, credit card interest was fully deductible," says Kathy Burlison, a tax research and training specialist with H&R Block Inc. "The Tax Reform Act of 1986, over a period of five years, eliminated deductibility entirely."
The move was part of a tax simplification plan launched during the Reagan years to shrink the number of federal tax brackets. Starting in 1987, only 65 percent of consumer interest was deductible. In 1988 it was 40 percent; in 1989, 20 percent; in 1990, 10 percent. The deduction disappeared altogether in 1991, Burlison says.
The law did, however, reserve deductions for first-mortgage interest and home-equity interest, with a few caveats that developed in the years immediately after. In cases where a home equity loan is used to improve the home, it's completely deductible, she says. If used for any other purpose, only the interest on the first $100,000 of the home equity line (up to the appraised value of the home) is deductible.
It all looks alike
Banks now promote credit lines almost like credit cards, with low introductory rates, no annual fees, plastic card access in some cases and all sorts of other incentives. Lenders as varied as Central Bank in Jefferson City, Mo., and Advantage Home Mortgage Corp. in Sparks, Nev., advertise lines and loans as ways to pay for everything from vacations to new cars.
So, what if the similarities in posturing lead to similarities in tax status?
Consider someone in the 28 percent federal tax bracket with a $50,000 balance on a line of credit that charges 8.66 percent, the most recent national average according to a survey. If that borrower makes a $1,000 payment each month, $4,018 in interest will be paid during the first year. The savings at tax time would be about $1,125. If the deduction was eliminated, that $1,125 would be lost to the government.
"Although there may be some in Congress that would like to close this 'loophole', I suspect that it will survive as long as there is a budget surplus," Mike Niemira said in e-mail correspondence. Niemira, an economist with Bank of Tokyo-Mitsubishi Ltd. in New York, has studied home equity lending.
"If the surplus disappears over time, then Congress might restrict the deductibility to home additions and improvements, and not consumer-related purchases."
Use is changing
He notes that the Federal Reserve reported in 1995 that only 7.5 percent of homeowners had a home equity line of credit. Sixty-four percent of those people used the funds for home improvement.
But studies show that home improvement may be less of a reason to borrow now than it once was. The Consumer Bankers Association has been tracking home equity lending for more than 10 years. It reviewed 1997 activity and found that only 23 percent of borrowers used home equity lines for home renovations or upgrades. Debt consolidation was the most common use.
"As (home equity lines of credit) grow rapidly, it is likely that this home improvement use will dwindle as a share of the total, which may hasten Congress' interest," Niemira adds.
Any legislative action could impact outstanding loans, since lines of credit terms range upward from five years. Borrowers should keep that in mind, but they needn't panic, because policy likely won't change overnight.
"You constantly hear more rumors about things of that nature, but I really think that the overall issue is what's best for the consumer," says John Barton, vice president for home equity lending at Chase Manhattan Corp. "My sense is that I don't see any immediate changes in the offing."
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