Home Equity Lending's Uptick: Why It's Good News for Homeowners and the Economy


home equity lendingBy Jeff Brown

Terrific news! Home equity lending is increasing!

OK, maybe it's not a world-changing event. But an uptick in home equity loans is more evidence that the housing market is strengthening. And it gives another loan option to homeowners who still do have equity despite the plunge in home prices after the financial collapse.

Whether a home equity loan is a good idea is, well, open to question.

Credit-data firm Equifax reported Monday that in August total balances for home equity installment loans increased for the first time since November 2007. It was just a smidgeon -- a rise of 0.3 percent -- but any gain is good.

Installment loans carry a fixed rate for the life of the loan, like a car loan or fixed-rate mortgage. You borrow a sum and make payments for a number of years. Another type of home equity loan, the home equity line of credit, or HELOC, carries a variable rate that can change monthly and works like a credit card, letting you borrow what you want, up to the credit limit, with monthly payments dependent on your outstanding balance and the current loan rate.

"The residential real estate market finally seems to be finding solid ground," said Equifax Chief Economist Amy Crews Cutts. "We're seeing signs that the contraction in mortgage debt is slowing and delinquencies continue to trend down at the same time that mortgage rates set new record lows on almost a weekly basis. The environment has been set for growth for a while -- now it looks like it may finally be happening."

Despite the uptick, Equifax said the total number of installment loans is 43 percent below the August 2007 level, at 4.4 million versus 7.7 million. Balances are down 49 percent from their peak in September 2007, at $143 billion compared with $278 billion.

And although mortgage rates are at 50-year lows, with the average 30-year fixed-rate loan going for 3.4 percent, installment loan rates are comparatively pricey. According to the BankingMyWay.com survey, the three-year installment loan averages about 5.5 percent, and the 15-year deal nearly 6.7 percent.

Like mortgages, the installment loans were crushed in the credit crunch. Fewer homeowners qualified because of financial setbacks such as lost jobs, and many "underwater" homeowners, owing more on their mortgages than their homes were worth, had no equity to support a home equity loan. Also, in a default, the home equity lender is second in line behind the mortgage lender, making it very difficult for the lender to recover what is owed in a foreclosure. Lenders therefore became very conservative about home equity loans.

While more homeowners are getting installment loans now, the comparatively high interest rates are an issue. Anyone wishing to borrow a large sum might do better with a cash-out refinancing, getting a new mortgage larger than the balance on the old one, and benefiting from today's low mortgage rates. An installment loan might be preferable to a mortgage if the loan will be relatively small, because the fees are likely to be much lower.

Similarly, one borrowing for a new-vehicle purchase might do better with an auto loan, as they are averaging 4 percent to 4.5 percent, with dealers occasionally going even lower. Keep in mind, though, that for most taxpayers the interest on home equity loans is tax deductible, while interest on auto loans is not.

For most people, home-equity loans are cheaper than credit card debt, which, like car loans, is not tax deductible. But the homeowner looking for a financial safety net should also look into a HELOC. Many of those start about 3 percent, though they might charge 5 percent to 6 percent after the first few months, depending on the borrower's credit rating.

That's a lot cheaper than a credit card, and there typically is little or no startup fee with a HELOC. But because there's no telling how high the rate could go in the future, the HELOC is best for borrowers who will be able to pay off their balances fairly soon.

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