“The US housing market continues to represent a ticking time bomb not just for lender balance sheets, but for the entire economy,” warn William C. Wheaton, et al, in an article in the article “Rebalancing the US Housing Market: Two Proposals,” in Real Estate Finance. Why the concern and warning?
One reason is the marked increase in both Home Equity Loans and Home Equity Lines of Credit (HELOCs). They increased some 20 percent in 2015 in what USA Today described as a “borrowing binge.” Their numbers are increasing, with even more expected this year, to the point where they are within 4.9 percent of the bad old days of 2008. It is missing one characteristic of the pre-bubble-burst era: borrowers have to actually have a credit score and be able to do more than hold the pen to sign their names. But even now, home equity loan standards have dropped to the point where a 620 FICO score can score a loan.
The number of home equity loans to subprime borrowers increased to more than $1.4 billion, up 32.7 percent year over year in 2015. HELOCs are up to $608 billion an increase of 6.8 percent in the same period.
Two kinds of loans come into play here: the home equity loan and the Home Equity Line of Credit (HELOC). A home equity loan is a second mortgage in a fixed amount that has a set repayment period. A HELOC is something like a variable-rate credit card, a revolving balance with money available whenever a homeowner wants to use it. There is a cap on the loan amount, but it works the same way as a credit card with a high limit in that homeowners can use as much or little as they want whenever they want, but with an interest rate much lower than a credit card’s. HELOCs are the more difficult to get because they require a higher credit score.
Gary Harman, vice president of Home Equity for Discover Financial Services, is quoted as saying, “Our minimum credit score is 620 (for a home equity loan), but the market is all over the place. If you wanted a HELOC, you would need a better score.”
This turnaround is due in large part to increasing home prices, giving homeowners equity in their properties. RealtyTrac reports that the number of “equity rich” homeowners, those with at least 50 percent equity in their homes, is around 19.2 percent. That means there’s considerable room to borrow against their homes. The lending limit is now 85 percent loan-to-value, but banks are just itching to increase that to 95 percent, as some nonbank lenders already have. While that’s a far cry from the 120 percent loan-to-value loans lenders touted before the real estate crash, it’s creeping up to point where the smallest downward blip in the housing market could put homeowners who take out home equity loans under water.
This borrowing is a stroke of luck for banks. Ellie Mae, a software provider for the mortgage industry, reports that home equity loans were 42 percent of lenders’ total volume in September 2015. No wonder they’re so enthusiastic to write more loans.
The lenders with the most itching fingers are credit unions and other non-bank lenders. Banks are pursing borrowers with at least a 750 FICO score for a HELOC, but other lenders, such as LoanDepot will look at 700 to 750 scores. They are willing to approve a loan “up to $250,000 (as long as the loan-to-value ratio does not exceed 95%) for a home equity loan,” reports a Feb. 17, 2016 New York Times article.
One of the differences between borrowing today and in the pre-bubble-burst days is that the money is going for “legitimate” expenses such as home improvements, paying off bills, and education. Lenders are discouraging borrowing for items that are “unneeded,” such as vacations and new cars. In a most patronizing statement, Gary Harman of Discover Financial Services said, “One reason I am not so enthusiastic about HELOCs is people have a tendency to use the money when they don’t really need it. If you’re using the money for home improvements, to pay down debt or have kids going to college, fine, but don’t take out additional money unless you have a real need for it.” Apparently he thinks people are too irresponsible to figure out when it is appropriate or needful to use borrowed money. But he is just trying to protect his company’s bottom line.
Even so, with home improvements paying back as little as 60 percent in increased home value and students coming out of college having to live with parents because they are unable to find any job, much less one that pays enough to pay off the loan their parents took out for them, the argument for using money only when someone has a “real need for it” falls flat. And who says we don’t need a vacation?
With credit requirements lowering and loan-to-value raising, as soon as housing prices drop, we’ll see more underwater loans and more loan defaults. The real estate bubble is growing and all it will take is one little pin prick to pop it.
By Robert L. Cain