One of the mortgage products that contributed to the housing crash is booming again: New home equity credit line borrowings soared by 42 percent in the final three months of 2013 and were up sharply for the entire year, to $111 billion.
But does this point to a return to the “my house is an ATM” mentality that characterized excessive home equity borrowing from 2004 through 2007, just before the crash? Should consumers — and the banks doling out the cash — be cautious about this trend?
Researchers at Experian Information Solutions estimate that originations of home equity lines of credit — HELOCs in mortgage industry shorthand — rose by 58 percent in the final quarter of last year in the Western states, 38 percent in the Northeast, and 36 percent in the Midwest.
The average line of credit for new borrowers with “super-prime” VantageScores (781-850) was $120,000. VantageScores are one of the two main types of risk-evaluation scores used by lenders. More ominously, new equity credit lines extended to owners with “deep subprime” scores (300-499) increased faster than in previous years and averaged more than $60,000, roughly triple the amounts in late 2010. On the other hand, according to researchers, serious delinquencies in outstanding HELOCs continued to be low, generally well under 1 percent.
What’s behind the equity credit line eruption? A record-fast rebound in owners’ equity holdings tied to rising home prices is one key. Between the third quarter of 2012 and the same period last year, Americans’ real estate equity accounts expanded by $2.2 trillion, according to the Federal Reserve. That growth is offering owners more options to tap their real estate wealth to fund home renovations, tuition payments, auto purchases and a variety of other consumer expenditures.
Banks are also pushing equity line products. Mike Kinane, senior vice president of TD Bank, said that home equity lines are providing a money-saving alternative to refinancing in a rising interest rate environment. With rates that are currently well below those quoted for fixed-rate 30-year mortgages, tapping home equity looks attractive to growing numbers of owners. TD Bank’s equity line rates go as low as 2.75 percent (prime bank rate minus half a percentage point) for qualified applicants.
Lenders I interviewed for this column, however, insisted that the rapid rise in new equity lines is different this time around, under much tighter controls. Cindy Balser, senior vice president of consumer credit products for Key Bank in Cleveland, says underwriting in 2014 is more intensive than it was a decade ago. Not only are credit limits more restrained — generally held to 80 percent of the home value, counting both the first and second mortgages against the property — but banks like hers require full appraisals or property condition reports by licensed appraisers to supplement electronically derived valuations.
But even with tighter controls, bankers and lending industry analysts acknowledge that there are potential downsides. Competition is encouraging some lenders to push their limits for combined first and second mortgages debt to 90 percent of home value or higher. That’s risky for them and for borrowers who could find themselves underwater in the event of another economic downturn.
Also, warns Amy Crews Cutts, chief economist for Equifax, today’s enticing interest rates are likely to increase. Since equity credit lines typically carry floating rates, borrowers could eventually find themselves paying much more every month than they ever anticipated.
Here’s what else to watch for if you’re thinking of jumping on the equity line bandwagon:
• “Teaser” rates. These short-term discounts on new credit lines may beguile you, but they are simply borrower bait. Focus on the index your credit line rate will be based on and the size of the “margin” tacked on by the bank. Run scenarios of what you might be paying if the index increases.
• Look for credit lines that come with an option to switch to a fixed rate if you choose. If your variable rate starts to take off sharply in future years, this will be a way to lock in your rate before things spiral out of control.
• Read the fine print. Credit lines can be complicated — your maximum draw can be limited or the entire line frozen under certain conditions. Your early payments may be interest-only but they’ll switch to full amortization at some point. You should understand all the features of your credit line before signing up.
Kenneth Harney is executive director of the National Real Estate Development Center.