Home equity loans can eat a home

`It's become too easy' to deplete the piggybank

Values are up, rates down

January 26, 2003|By Patricia V. Rivera | Patricia V. Rivera,SPECIAL TO THE SUN

A growing number of consumers are choosing to use the equity in their home as collateral for credit, allowing them to do anything from consolidating debt to paying a child's college tuition to funding a trip to Tahiti.

If they are not careful, however, what seems like a safe asset could turn into anything but that, experts said. Homeowners could end up losing their home if they can't make the payments.

"It's become too easy to deplete the best piggybank available right now, which is your home," said Keith T. Gumbinger, a vice president of HSH Associates, a financial publisher in Butler, N.J.

The appeal of home equity loans is easy to understand.

Many of those interest rates move in lockstep with the prime rate, which now hovers near 4.5 percent. That is considerably lower than credit-card rates that can reach 20 percent or higher. Soaring home prices have provided more equity to homeowners, who have seen average values rise by 30 percent nationally during the past five years. And home equity loans often allow tax deductions on the interest paid. Home equity lines of credit now can be accessed by telephone, by credit card and by check, making them easier than ever to tap.

"Choosing a home equity line in this economy is a no-brainer," said Vijay Lala, senior vice president at Countrywide Home Loans Inc., a unit of Calabasas, Calif.-based Countrywide Financial Corp.

The Federal Reserve's latest "flow of funds" reports shows that home equity lines of credit increased 92 percent from 1997 to the third quarter of last year, compared with 53 percent for all home mortgages.

The average home equity line of credit account was drawn on five times for a total of $10,642 last year, up from 3.8 times for a total of $6,571 in 2001, according to the Consumer Bankers Association based in Arlington, Va. The proportion of dollars outstanding rose to 53 percent from 48 percent.

The interest in home equity credit reflects a change in the ways consumers view their homes, said Joe Rogers, executive vice president at Wells Fargo & Co. in Columbia.

"Recent economic trends have pushed up the value of people's homes while the value in other investments has not been as strong. They now see their home as an asset rather than a place where they have debt," he said.

But some experts worry that as interest rates rise, some unsuspecting consumers could be left debt-ridden and even homeless.

The reason: Consumers don't always understand that they're using their home as collateral by taking out the lines of credit, said David Berman, a Timonium financial planner.

"What's going to happen when rates go up is that, all of a sudden, people who didn't have a problem paying for the loan will start struggling with it. That's a big risk," Berman said.

As a result, financial planners and debt counselors say they already are seeing people who find themselves in a bind with the credit lines that can be accessed at any time. Part of the problem is that consumers who use the home equity credit lines for debt consolidation aren't closing their higher interest credit-card accounts once they pay them off, said Rudy Cavazos, a spokesman for Money Management International in Houston, a nonprofit credit-counseling service.

"It's a great idea to consolidate but if you don't modify your lifestyle, you'll fall right back into the same problem and that's what we're starting to see," he said.

About 38 percent of home equity lines are used to pay off debt, with 24 percent going to home improvements, according to the Consumer Bankers Association.

The fact that consumers use credit cards encourages some unnecessary spending, Gumbinger said.

"Plastic access to your equity trivializes everything since there's no stigma attached to the money you're spending," he added.

About 33 percent of financial institutions surveyed by the Consumer Bankers Association offer credit cards to help tap home equity lines. Other financiers are considering the option, including Countrywide Home Loans because consumers are asking for the access, executives said.

"Consumers want that flexibility," Lala said.

Saxon Birdsong, director of investments for Baltimore-Washington Financial Advisors in Ellicott City, said he sees that such lines of credit help some consumers manage their debt more efficiently.

"Most people in a difficult, over-extended situation feel the pain and want to get out of their situation," said Birdsong, who also is a board member of Consumer Credit Services of Maryland and Delaware.

To be sure, reported foreclosure rates on home equity lines still fall below those of standard mortgages.

But the weak economy has pushed home loan foreclosures nationwide to a record level.

The Mortgage Bankers Association of America reported recently that the percentage of loans in foreclosure rose to 1.15 in the third quarter of last year, up from 1.13 percent in the second quarter and the highest level since the trade group began tracking them in 1979. The previous high of 1.14 percent was set in 1998.

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