Home Equity Credit Cards

Recall that under the Tax Reform Act of 1986, Congress removed the tax deductibility of interest paid on consumer loans except for loans secured by a primary residence. A stated objective was to discourage the use of “high priced and dangerous” credit card debt and to encourage home ownership. For the past decade, home equity lenders have encouraged consumers to pay off their credit card balances with home equity loans. Part of the “pitch” has been that the interest cost of loans secured by home equity is a tax-deductible expense. 

Now the market has found a way to encourage both homeownership and credit card usage. Recently, the columnist Kenneth Harney points out that a major lender is now offering consumers the opportunity to obtain credit cards secured by their homes. Washington Mutual Bank, the nation’s fifth largest mortgage originator is offering an “On the House” Visa card that is embossed with a picture of a house. Following a teaser rate of 5.99 percent for the first six months, the rate goes to prime plus an addition of between 0.75 percent to just under one percent. The credit line can be much higher than that on unsecured bank credit cards, with the limit depending on the value of the residence, net of any outstanding mortgage debt. Since this arrangement may lead to lines of credit of as much as $500,000, Harney refers to it as “a platinum card on steroids.” It is good for 10 years, and the bank may eventually offer add-on features, such as frequent flyer miles. 

The after-tax interest cost on the card is very attractive. A consumer who is revolving on his or her credit card account might be paying 18 percent. Since the interest is not tax deductible, that is the consumer’s full after-tax cost. In contrast, suppose that a consumer has an On the House card with a rate of 6.8 percent. A consumer in the 40 percent tax bracket will be paying an after-tax rate of 4.08 percent [0.6 x 6.8], less than a fourth of the after-tax rate on a regular credit card account. 

Consumers who do not revolve on their credit card accounts would be unlikely to seek On the House cards unless they sought higher lines of credit. Since they are not paying interest for their use of credit now, why adopt an arrangement whereby they are always paying interest so long as they have a balance? Stephen Brobeck, executive director of the Consumers Federation of America, argues that the card makes it much too easy to spend the savings that they have invested in their home equity. His remedy would be for lenders to cap the credit lines at what he considers a reasonable amount, such as $5,000.

 

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