Sushil Tuli – Credit card danger

While people are worried about the economy, they aren’t panicking. Instead, they are hunkering down and taking advantage of low rates to reorganize their debt loads, according to industry insiders.

Home equity loans and lines of credit have been increasing steadily but haven’t outpaced refinancings, which have hit record numbers this year.

New growth has been very strong but much of it has been running off as people refinance their mortgages, so that would mask the numbers a little bit, said Fritz Elmendorf, spokesman for the Consumer Bankers Association. The CBA last week released its 2001 Home Equity Study, which found home equity lending volume grew by 17 percent nationwide and consumers favored credit lines rather than loans during the year ending June 30, 2001.

At FDIC-insured commercial banks there were $135.2 billion in outstanding home equity loans as of the second quarter this year, compared to $116.2 billion worth of home equity loans during the same period last year, said Elmendorf.

In addition to low interest rates, Elmendorf said banks are using strong marketing tactics to spur business. Our survey shows that closing costs continue to drop dramatically as a reflection of strong competition. [Banks] are waiving closing costs. They’re offering the products sometimes as low as prime rates, he said, noting there may be teaser rates associated with it. Sixty-one percent of banks used reduced-interest teaser rates for the year ending June 30, 2001. The study reported that banks are offering teaser rates from 90 to 365 days.

Although business has been good in the home equity market, it’s been much, much better in the refinancing area due to low interest rates.

We’re seeing an awful lot of people refinancing and paying off the home equity balance they have, said Margaret Lawlor, senior vice president and acting marketing director for the consumer lending group at FleetBoston Financial.

While a greater number of prepayments on home equity loans isn’t great news for the industry, Lawlor said she’s seeing strong demand for home equity lines of credit because of low interest rates. Prime is at 5 percent, and prime hasn’t been at 5 percent in over 20 years, she said.

Consumers are taking out lines of credit mostly to pay down debt like high-interest credit cards, she said. The CBA study found that 52 percent of home equity loans and 47 percent of home equity lines were taken out for the purposes of debt consolidation. According to Elmendorf, that’s the first time that the percentage of equity taken out for debt consolidation purposes has reached that high.

But while people are taking out lines of credit and home equity loans and refinancing like wildfire, the downshifting economy is not yet affecting repayment rates.

The performance holds up very well. There’s been no evidence to date of a significant increase in delinquencies or losses, although bankers now are wary, said Elmendorf. Our survey may show a little increase [in delinquencies] but anecdotally, from talking to a lot of the major lenders in October at our conference, they were saying that no, they’re not seeing problems, but they are watching, he said.

While 70 percent of lenders surveyed said their customers are borrowing up to 100 percent of the value of their homes, consumers aren’t seeking to max out equity locally.

‘House in Order’
According to Dean Caso, president of Homevest Mortgage Corp. in Newton, although refinancings and home equity lines have increased, most people are seeking no more than 90 percent of a home’s value.

We’re not seeing people take what I would call any kind of a desperation measure, said Lawlor. We’re seeing many, many customers, thousands, who have sufficient equity and sufficient cash flow to borrow more than they’re borrowing … People are prudent and are either on their own taking these steps or they’re listening to a financial advisor who’s saying these are some prudent steps you can take to get ready just in case.

The most remarkable trend we’ve seen over the last couple of months is people getting their financial house in order, said Lawlor. That translates to refinancing first mortgages because rates are lower than they have been in 20 years. Three-year fixed rate mortgages are below 7 percent with zero points; 15-year fixed rate mortgages are below 6 percent with zero points which is a heck of a rate, said Lawlor.

Many times when they [consumers] pay off their first mortgage – refinance it – they’re also refinancing an equity line at that same time. In the last six or eight months, and certainly in the last couple of months as mortgage rates have gone even lower, we’ve seen a fair amount of equity loan payoffs in conjunction with the first mortgage refinance in order for that homeowner to fix the lowest rate, she said.

Caso said he’s experienced a flood of refinancings for cash. He noted that banks are oftentimes able to provide a more competitive rate for home equity loans.

One of the things I’ve noticed is we’re supporting a ton of home equity lines on our refis. In other words, people who have already had a home equity line are not paying it off; they’re keeping it. I’ve noticed too that a lot of borrowers are either adding an equity line with us or maybe going directly to a bank, he said.

Caso said many are taking out equity lines as a security blanket and not spending the money. Instead, if they need cash, they’re likely to do a cash-out refinancing with a fixed rate instead of the variable rate offered on home equity lines.

It’s a very smart move, said Lawlor. It’s particularly smart to do it now if people are nervous, with the economy the way that it is, about losing a job or having their hours cut so that maybe their compensation over the next several months is going to be lower, she said. Sales people are also looking at reduced commission levels until the economy gets better, she pointed out.

We are seeing some people taking a home equity line of credit just in case. ‘I want to make sure I have $25,000 or $50,000, my home value is strong, home purchase prices and home appraised values are high this year.’ You can’t take out a loan when you’re unemployed, she said.

But while consumers are taking advantage of low interest rates and the equity in their homes to prepare for leaner times, Sushil K. Tuli, chairman and chief executive officer of Leader Mortgage in Arlington, said he’s worried that while people are taking advantage of lower interest rates to consolidate their home equity loans and first mortgages and paying off debt, he’s worried some will re-load their credit cards with more debt. It will help the economy but, in the long run, it will be bad for consumers, he said.