Hocking the family home to pay down credit cards has become an American tradition. But a new twist-loans that exceed the home's value by up to 50%- has some in Congress worried. An estimated $15 billion of such loans are outstanding.
Concerned that some borrowers would wipe out their home equity, only to run up their credit cards again, Sen. Lauch Faircloth, R-N.C., has asked the General Accounting Office to study the trend. He will hold a hearing in May.
James M. McDermott, assistant director of the GAO, said the agency is asking three basic questions: Who is making these so-called high-loan-to- value loans? How much money was lent in the past two years? And what portion of the loans is delinquent? The GAO will report its findings this summer.
Jim Hyland, who is Sen. Faircloth's legislative director, said the lawmaker is "aghast at the very notion that people are borrowing in excess of value of their home. He thinks it's an unhealthy trend." Sen. Faircloth is worried that banks and thrifts could lose money on the loans, Mr. Hyland said.
In 1997, Americans spent 17% of their after-tax income, on average, to make principal and interest payments on their debt. That's a high proportion by historical standards, and home equity loans have become an important safety net for homeowners who are too deep in debt.
Rates on home equity loans are lower than on credit cards and car loans, for example, and interest is still tax-deductible. Consumer loans lost that preferential treatment in 1986.
At the end of 1997, borrowers owed $420 billion in home equity loans. Fixing up the house is another common use of such loans.
Advocates of high-LTV loans say Sen. Faircloth's worries are misplaced, because the loans are made to households with good track records of managing debt.
The typical borrower is a couple in the 26-to-40 age bracket with household income in the $70,000-to-$80,000 range, said Peter H. Bell, executive director of Home Improvement Lenders Association.
"People go through a period when they have a run-up in expenses: furnishing the house, kid paraphernalia," Mr. Bell said.
"With this product you get through that spending hump" by restructuring the monthly cash flow, and income gradually catches up with expenses, he said. "This is not a product for the chronic debtor."
A survey conducted by the University of Michigan for the Federal Reserve Board found that home equity borrowers tend to be more affluent and financially sophisticated than others. Delinquencies on home equity loans are also lower than on any other household debt.
Mark Zandi, chief economist of Regional Financial Associates, says fierce competition for the consumer credit dollar is likely to lead lenders to relax their credit standards on the new high-LTV loans.
"There are some reasonable arguments for high-LTV lending," Mr. Zandi said. "To some degree it reduces the credit risk of the borrower, because the borrower is consolidating all of his debt at a lower interest rate that is tax deductible. So in theory, if you are lending to people who have pristine credit, then these are good loans."
As more lenders enter the sector, lenders probably will start making these loans to borrowers with a little blemish on their credit histories, a little income volatility, and pretty soon, the loans will run into trouble, Mr. Zandi predicted.
The competition between credit card lenders and home equity lenders for consumer credit dollars may make matters worse by giving high-LTV borrowers access to large credit card lines.
Part of the problem is that credit card lenders may not know that a potential borrower has a high-LTV loan. As the data is currently gathered, the borrower's financial profile would show a large first or second mortgage, but it would not be evident that the loans exceed the home value, Mr. Zandi said.
As for families who sign on for additional credit cards, they have the best of intentions, Mr. Zandi said.
"Suppose a (card) lender offers a $5,000 to $10,000 credit line. Why wouldn't you take it?" he said. "You don't mean to use it" unless there's a problem-unemployment, illness, a death in the family. If that happens, the family may end up with more debt than they can keep up with, Mr. Zandi said.
"The high-LTV lender is hoping and betting that the credit card lender won't make that offer," Mr. Zandi said.
That, he warned, may be a losing wager.