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Home equity loans: Why they're popular

The practice of borrowing against the value of a home has skyrocketed in popularity.

There are two key reasons for this surge: low interest rates and tax deductibility.

When tax changes in 1986 eliminated deductions for most consumer purchases, home equity loans became a way to buy goods and still get a deduction.

Let's say you bought your home for $95,000 and made a 20 percent down payment of $19,000. You then took a first mortgage to pay the remaining $76,000. On the day you closed on your home, you automatically had 20 percent equity. You gain equity as you pay off the principal and your home grows in value.

Let's say you've paid $12,000 toward the principal and your property -- valued at $95,000 when you bought it -- is now worth $115,000. Your beginning equity ($19,000), plus the principal you have paid ($12,000) and the increase in your property value ($20,000) gives you $51,000 in equity.

Banks and borrowers love it

Equity is a valuable asset because you can put it to use without having to sell your home. And because most people's domicile is their biggest asset, lenders regard home equity loans as secure. For that reason, interest rates are lower than for other loans.

The average rates for a home equity line of credit or for a term equity loan are available from Bankrate.com's current survey of 4,000 banks around the country.

Home equity products usually have a higher interest rate than first mortgages. (Bankrate.com's mortgage rate survey will show you those differences.) But compare home equity loan costs to your credit card or department store charge cards. Check out Bankrate.com's current credit card rate survey, then figure in a tax deduction on your home equity loan, in most cases for up to $100,000 of borrowed money, and you've got yourself a deal.

The scary part is that if you default on the loan, the lender could foreclose on your home. That's why these loans are statistically most suited to stable, middle-aged borrowers. The average home equity customer is 35 to 49 years old with a household income of $63,000, according to the Consumer Bankers Association. Fifty- to 65-year-olds are the second biggest borrowers of home equity.

Most have held the same job and owned their home for about eight years. Less than 2 pecent default on their loans.

"Home equity customers tend to be very good at paying back their loans," says Bill Hampel, chief economist for the Credit Union National Association in Washington, D.C.