When experts look at people’s finances, they usually advise them to reduce or eliminate debt. Put every extra penny into savings accounts and build up investments. They will tell you that money you’re paying in interest is money that could be earning interest somewhere.

But most Americans don’t live like that. People take out loans for houses, cars, education, and other things they want now, not later. After all, how long would it take to save up enough cash to buy an average American home?

Buying on credit helps Americans enjoy a higher standard of living than they would if they had to pay cash for everything. But some borrowing makes more sense than other kinds of borrowing.

For example, it makes sense to borrow money when interest rates are low. Depending on how our economy is doing, the Federal Reserve Board raises or lowers the discount rate. This rate affects the interest you pay for loans, and this rate can change a lot. It has been as high as 14% in 1981 and as low as 1% in 2003.

Loans on Houses and Home Equity

Home loans (mortgages) make sense because most houses appreciate (increase in value) the longer you own them. You can also deduct interest you pay on the mortgages of your home and one vacation house from your income taxes.

In something called “cash-out refinancing”, you get a new mortgage loan for more than the unpaid principal balance of your current mortgage. This allows you to spend the equity accumulated in your home.

Another way to get at the money in your home is by taking out a second loan, called a home equity loan. With home equity loans, you can deduct the interest you pay from your income tax.

Many people take out home equity loans to not only make home improvements, but also to purchase cars, motorcycles, boats and other luxury items, or to consolidate other debt.

When the interest rate is lower on home equity loans than other personal loans or credit cards, then it makes sense to choose the home equity option and deduct the interest paid (up to $100,000 on things other than home improvement).

Most financial institutions used to require a 20% down payment to get a mortgage, and you could not get a home equity loan for more than 80% of your home’s value. The thinking was that you would be less likely to default (not pay the loan) if you had a big stake in it. But the cost of houses increased so much that many people couldn’t afford such big down payments, so lending rules loosened up.

Some people take out these loans during an urgent financial crisis and don’t realize the associated costs and risk of losing their house if they can’t make the payments.

Loans To Help Your Future

The interest on personal loans is not tax deductible and you cannot get government help with them, so they tend to be the most expensive.

Most people take out loans only for houses, cars, boats and RVs, and put everything else on credit cards if they don’t have enough money at the time of purchase. However, credit card loans, because they are unsecured, usually carry the highest fees and interest rates.

Consider, too, that cars, boats, RVs plus most things you buy with credit cards lose value (depreciate) the longer you own them.

If you must use credit, shop around for the best deals. Financing companies usually are the most expensive lenders, followed by commercial banks, savings banks, and savings and loans associations. Credit unions often have the most competitive interest rates.

So When Are Loans A Bad Idea?

Certain kinds of loans are rarely ever a good idea. They include payday loans, pawnshop loans, title loans against your car’s value, home equity loans for more than the value of your house, tax refund loans and advance fee loans in which you pay someone to find you a loan. With these, you risk getting taken or paying too much in interest and fees.

For complete information on home mortgage interest deductions, see IRS publication 936.