When Carol and Daniel Thalimer found bankers unwilling to provide them with a small- business loan to expand their travel agency several years ago, the couple turned to the next biggest source of cash they could think of--their home. The four-bedroom house in Roswell, Ga., an upscale suburb north of Atlanta, had appreciated 36% over the years and was worth $136,000. Bankers didn't hesitate to advance the Thalimers a home-equity loan of $45,000.
Nowadays, the Thalimers, and many other families, have come to regard their home-equity loan with very mixed feelings. After selling the travel agency in 1988, the Thalimers didn't have enough money to pay off the loan. And with their income reduced now that Carol is a free-lance writer while Daniel writes user manuals for a computer software company, it's a struggle to come up with the monthly $525 for the first mortgage and the additional $725 for the home-equity loan. Recently, they turned to a debt counselor for help. "It's like being on the edge of a precipice," says Carol. "If anything goes wrong, or any unexpected expenses pop up, it's all over. We'll lose the house."
Spurred by the 1986 Tax Reform Act, home-equity loans are widely regarded as a great deal for banks and borrowers. Although Congress phased out interest deductions on most consumer credit, interest on home-equity loans remains deductible. For popular home-equity lines of credit, or HELs, interest on borrowings of up to $100,000 is deductible. And the cash can be used for any purpose, from auto purchases to vacations. Growing at an average annual pace of 55%, balances on revolving HELs stood at an estimated $132 billion at the end of 1991. In all, second mortgage debt totaled $357 billion.
NO NEST EGG. Yet it's becoming increasingly clear that the home-equity phenomenon has an ominously dark side--for both lenders and borrowers. Although delinquency rates remain low, thousands of families like the Thalimers may be barely keeping up their loan payments.Debt counseling services in various regions say consumers with home-equity loans have begun showing up in greater numbers.
This could prove troublesome to the already sputtering recovery. It was widely believed that consumers were reducing debt levels. And once they were in better financial strength, households would spend more, giving a badly needed boost to the economy. But Robert W. Johnson, senior research associate at Purdue University's Credit Research Center, believes the improvement in consumer balance sheets may be exaggerated, in part because of the use of home-equity loans. "I think consumers are merely changing the form of the credit they use," he says.
Critics, further, have begun questioning the long-term wisdom of loading more and more debt on the U.S. family's biggest asset. Homeowners controlled nearly 70% of the equity in their houses in 1983. But owing to a combination of falling real estate values and increased mortgage borrowing, that ownership was down to 55% by 1991 (table). "Those houses won't be there as a nest egg for retirement," says economist A. Gary Shilling.
Lenders also have good reason to worry. "It's conceivable that banks are holding loans for more than what the house is worth," says Federal Reserve Governor John P. LaWare. Banks and regulators, who used to regard home-equity loans as impeccably safe, are starting to take a much closer look at collateral values. Lenders may eventually have to renegotiate terms on many existing loans.
Despite these concerns, home-equity loans, chiefly HELs, remain wildly popular. Michael Roy, who oversees home-equity lending for San Francisco-based First Nationwide Bank, a subsidiary of Ford Motor Co., says these loans are running 30% above last year's volume. "The home-equity line is the product of choice," he says.
Lenders are hawking HELs at variable rates ofjust 1.5 to 2 percentage points over prime, and promoting new uses. NationsBank Corp. in Charlotte, N.C., is planning to expand a "Tax Smart" auto loan secured by a lien on the borrowers' home. Only 28% of borrowers used their HELs for home improvement in 1991, according to the Consumer Bankers Assn.
The anemic economy has set many experts to thinking whether home-equity loans are far less secure than popularly believed. "I've heard of isolated incidents where people use their home-equity line as a form of unemployment insurance," says the Fed's LaWare.
Fueling the suspicion that trouble is brewing is the lack of hard facts on HELs. The Federal Deposit Insurance Corp. began tracking HEL delinquencies only last year. At the Fed, most data on HELs are lumped into overall mortgage figures. "It's hard to get good numbers," says economist David Wyss of DRI/McGraw-Hill. "Even the banks don't track them as closely as we would like."
As a result, the official figures showing low delinquency rates on home-equity loans are being questioned. Many HELs have easy payment terms. Some require minimum monthly payments as low as $100. "What worries me," Wyss says, "is that people may be using their lines just to pay their interest."
Problems have already begun to crop up in certain regions, such as the hard-pressed Northeast, which accounts for 38% of HEL balances at banks. First-quarter delinquencies at Providence-based Fleet/Norstar Financial Group Inc. were running at 5% on fixed-rate second mortgages and 2.5% on HELs--more than twice the national norm. Fleet believes its problems have peaked. In California, Citicorp says delinquencies stand at 2.6%. Citi says its portfolio is still performing well, but the bank has begun drive-by appraisals to check on home values and annual loan reviews on some accounts. And David A. Brooks, head of Citi's West Coast consumer lending operation, confesses to some trepidation. "The big unknowns are how long the recession will last and what will happen to real estate values," he says.
STUBBORN. Even if the recovery gains steam, home-equity loan problems could fester. Unemployment, especially among white-collar workers, the biggest HEL users, will likely remain stubbornly high. Moreover, it takes time for the benefits of any economic expansion to filter down to households. After the 1982 recession, second-mortgage delinquencies didn't peak until 1985. Because home-equity lines are a relatively new product, economists aren't sure how delinquency rates will run. Says Susan Sterne of Economic Analysis Associates in Stowe, Vt., "What will happen? It's a big question."
Especially vulnerable are consumers who use HELs for debt consolidation, to pay off expensive credit card and auto loans. True, that reduces their interest tab. Unfortunately, many homeowners don't have enough discipline to restrain their buying habits. Before long, debt counselors say, they are out using their credit cards again. "Based on our experience, fully 75% of all people who use their home value for debt-consolidation loans find themselves twice as indebted within two years," says Katie M. Shern, education director for the Consumer Credit Counseling Service of North Georgia.
Perhaps a more pressing concern to regulators is the value of the collateral securing home-equity loans. Over the past couple of years, lenders have tightened standards. But in the competitive frenzy of the late 1980s, when a collapse of real estate prices seemed inconceivable, bankers relaxed limits on the amount of money they were willing to advance. Loan amounts, including the first mortgage, often equaled 85% of the value of a borrower's home, leaving a thin 15% equity cushion. But that margin has vanished for many homes, especially expensive ones.
A CRACKDOWN? To forestall the possibility that home-equity loans may become yet another in a long string of lending disasters, regulators have stepped up pressure on bankers to review their portfolios. Attorney Charles F. Byrd, a specialist in regulatory law, predicts a more vigorous crackdown. Ultimately, he believes bankers may be forced to restructure terms with many homeowners whose houses have significantly dropped in value or whose income has dwindled. Some lines could be curtailed.
While that may put bank balance sheets in order, household balance sheets may continue to weaken. For several generations, home ownership has been a form of forced saving. Retirees could support themselves by cashing in on the steady appreciation of the value of their homes. But the continued growth of home-equity borrowing--coupled with, at best, moderate gains in home prices for the rest of the decade--could mean continued shrinkage in Baby Boomers' equity stake in their homes. Signs of that loss of wealth are already visible. Many homeowners can't afford to trade up to larger homes because they lack sufficient equity for a downpayment. In some regions, home-equity loans "have tended to freeze people in place," says John A. Tuccillo, the chief economist for the National Association of Realtors.
Growing signs of the worrisome drawbacks of home-equity loans have provoked debate over curbs. Some consumer advocates say using tax-deductible HELs to buy cars or take vacations defeats the 1986 Tax Reform Act's goal of eliminating interest deductions on consumer loans except for home mortgages. Congress, too, is concerned. And it discriminates against people who don't own homes. By September, the General Accounting Office is due to release an extensive study on how home-equity loans are used and how much tax revenue they cost.
Still, don't expect any reform during the current election year, and possibly beyond. Limiting deductibiliy for taxpayers is fraught with political peril. Some advocates of home-equity loans also say the government has no right to tell consumers how to use the value locked up in their homes. "They should be able to access that equity based on their needs," says Debra Danburg, a member of the Texas legislature. Danburg is leading a campaign to change provisions in the Texas constitution that limit the use of home-equity loans to home improvements and tax payments.
Still, the final solution doesn't lie with lawmakers, or for that matter, bankers. In the end, the question is whether homeowners will be able to discipline themselves and do a better job of protecting their most valuable asset.