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Home Equity Borrowing Has Become Just Another Debt Staff - Mortgage Lenders Plus.com

When the Silicon Valley start-up phenomenon took flight, many who watched and participated in it bought into a near-term spike as an entirely new era. There was to be no end to the clever and enormously lucrative digital ventures that enjoyed stock run-ups while having generated no revenue with no business plan. To some extent, that has happened to home owners. Those who took out loans or credit lines based on the sudden jump in home equity that came upon them with the rapid appreciation in real estate, now find themselves with variable home equity loan rates that are suddenly putting a burden on the family budget.

The debt explosion, driven by a doubling of home mortgage debt to $8 trillion since 1998, can pose substantial risks to individual borrowers who are now responsible for both a mortgage and a second note or line of credit. To be sure, both the interest from the principal mortgage and the home equity loan interest are deductible, but that does not change the fact that millions of Americans owe billions more than a few years ago, and will owe that money for longer periods of time.

From 2000 onward, borrowing as a percent of income has exploded to record levels well beyond previous highs set in the late 1980s. While in past decades Americans binged on credit card debt, in the 2000s, the preferred way of going into debt is first and second mortgages. Even those with fixed rate first mortgages often took on variable home equity loan rates when interest indexes were at record lows.

Consumers learned that the easy credit terms now available on mortgages enable them to borrow much larger amounts than they can with credit cards, and the debt does not have to be paid off for five to 40 years, if ever. The discovery of easy mortgage financing and low home equity interest led U.S. households to escalate borrowing to more than $1 trillion for the first time in history in 2004 and 2005. Before 2000, consumers had never borrowed more than $488 billion in one year, according to Federal Reserve statistics.

Keith Leggett, senior economist with the American Bankers Association, said banks liberalized their lending terms to comply with consumers' desire to free up their home equity - in past eras, a largely illiquid asset - and convert it into cash. That often took the form of variable home equity loan interest rates. Withdrawals from home equity exploded to an estimated $800 billion last year from $66 billion in 2001. Although some of that was used to remodel homes and pay down credit-card debt, homeowners used most of it on items from cars to college education, surveys show.

Variable home equity loan interest rates of 1 percent to 2 percent were introduced, and banks started routinely approving loan packages that require 50 percent to 60 percent of a borrower's gross income, before taxes, to pay each month. These offerings enticed borrowers, even though the extraordinarily low home equity loan interest rates advertised may last only a few months and the mortgages often include other harsh terms, such as penalties for prepayment of the loans. In the end, it’s just a larger payment each month for several more years beyond the original mortgage.