High-loan-to-value lending is less risky than it appears, according to a newly released study.
What's more, the economy as a whole is more stable because of high-LTV lending, which should not be viewed as a "sleazy" or "reckless" activity, according to "High Loan to Value Lending: Problem or Cure?"
The study, sponsored by the American Enterprise Institute for Public Policy Research, was presented Wednesday in Washington by Charles W. Calomiris, a professor at Columbia University's Graduate School of Business.
Banks have increasingly been making the controversial loans, which let homeowners borrow up to 150% of the value of their homes. Many use the money to pay off credit card debt.
In recent weeks, the Office of Thrift Supervision has said it will review the popular product, in part because of fears it is encouraging people to load up on debt.
The study, done by two professors from the Columbia University Graduate School of Business, high-LTV lending has evolved to "compensate for the deficiencies of the consumer bankruptcy law by making it possible for consumers to commit" themselves credibly "not to voluntarily default on debt."
Because these loans have lower interest rates, and are collateralized by a person's house, the study said, they are less likely to go into default. And they are a claim on an asset that would be protected, otherwise, from seizure by creditors if a borrower did default.
"The movement from other credit (like credit card debt) into high-LTV reduces both leverage and default risks," the study says.
"Reloading"-when people pay off credit card debt with a high-LTV loan only to rack up more card debt-or "churning"-when people clean up their credit rating and then apply for a larger high-LTV loan-are lesser problems than was feared, the study argued.
"High-LTV lenders explicitly guard against reloading and churning" by limiting loan size to just above a borrower's outstanding debt level and by tightening credit standards for those with existing second mortgages.
Though they have been referred to as "subprime," the loans are also "typically granted only to sound credit risks," the study said.
Many high-LTV lenders also have subprime divisions, which confuses the issue. But lenders offering both types of loan have been striving to distance the two businesses, though those with only high-LTV divisions have been seeking borrowers with higher credit quality.
If the secondary market for high-LTV loans dries up, problems could ensue, the study noted. But the "probability of that occurring is remote," in part because of safeguards built into the securities.
The loans could be credited with safeguarding the U.S. economy because they let borrowers exercise "smooth consumption," the study said. During recessions, homeowners can turn to high-LTV loans to fund purchases they would have made if the economy were strong.
