Hocking the house to pay off the cards Home equity loans used for debt consolidation

Nation's Housing

July 05, 1998|By Kenneth R. Harney

IN THE FIRST study of its kind, researchers have documented the dimensions of the vast financial shift under way among American consumers to convert their consumer debt -- especially credit card balances -- into home mortgage debt.

During the past 24 months alone, according to researchers, 4.2 million American households have converted a stunning $26 billion of credit card debt into home equity mortgage debt.

Aggressively pitched on TV by sports celebrities such as Dan Marino and Jim Palmer, and promoted by endless blitzes of direct mail, home equity loans and lines of credit have become the "debt-consolidation" tool of choice for millions of families.

The rationale is powerful: Revolving credit card balances often carry interest rates in the high teens.

Home equity debt for borrowers with good credit ratings often costs less than 10 percent.

Even for homeowners stretching the envelope by borrowing 125 percent to 150 percent of their home's value with equity loans, interest rates are still at least several percentage points cheaper than for credit cards.

And, thanks to federal tax law, some or all of the interest paid on mortgage debt is tax-deductible -- lowering the effective cost even further.

Credit card and other revolving consumer debt, by contrast, receive no tax breaks.

"We had no idea how big this [shift] really was," said Bruce Brittain, president of Brittain Associates Inc., an Atlanta-based market research firm.

Brittain's study, originally designed for credit card and bank clients, is based on interviews with a large statistical sample of 6,066 households. This size sample, according to Brittain, allowed him to project national totals with a statistical reliability of plus or minus 1 percent.

Brittain says he was "disturbed" by the number of homeowners who appear to be using equity loans as a vehicle to load on more debt.

Of the 4.2 million households that used equity loans to pay off some or all of their credit card debt during the past two years, according to Brittain, fewer than 1.5 million were still credit card debt-free when the survey was completed last month.

That means roughly two out of three homeowners who take out a debt-consolidation equity loan to pay off credit cards are then letting credit card debt rise again.

For example, say a couple with $20,000 in credit card balances took out a $30,000 home equity loan in May 1997 and paid off their entire card debt with the proceeds. By the end of 1997, they were back to their old credit card habits and started building up monthly unpaid balances.

By May of this year, a year after they got their debt-consolidation mortgage, their card balance was back up to $5,000, and their equity loan principal was slightly under $30,000.

Total debt-load change since May 1997: Their $20,000 in card debt has now grown to $30,000 of mortgage debt plus $5,000 of new card debt.

Brittain, for one, thinks the pattern is worrisome. On the one hand, he said, "you've got people out there who are very aggressively selling debt" -- both home equity lenders and credit card companies and banks.

On the other had, you've got a substantial number of homeowners who are using equity loans to feed their high-spending habits. With just a moderate downturn in the economy, many of these over-stretched families could be in trouble -- delinquent first on their credit cards, and then on their equity loans.

Problems with the latter, of course, could cost them their home. Brittain is not alone in his concerns about the impact of billowing debt-consolidation home equity finance.

The U.S. General Accounting Office (GAO) currently is conducting a study of one controversial segment of the equity loan business -- loans that exceed 100 percent of a homeowner's equity, known as "125 LTV" (loan-to-value) mortgages.

Using a 125 LTV loan, the owner of a $200,000 house with a $175,000 first mortgage could take out a $75,000 debt-consolidation equity loan in the form of a second mortgage.

The combined debt from the first and second mortgages would total $250,000, or 25 percent more than what the home would sell for.

Sen. Lauch Faircloth, a North Carolina Republican, plans to hold hearings on the size, growth and marketing practices of the high-LTV equity loan business this month.

Based on Brittain's research, one early conclusion likely to emerge from the Senate hearings is this: If you hock your house to the hilt -- or beyond -- to pay off your cards, then stay off your cards. That way you'll be more likely to stay in your house.

Pub Date: 7/05/98

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