HELOCs and Rising Interest Rates

It's been some time since HELOCs (Home Equity Lines of Credit) have been given much thought in this household. Having temporarily transitioned from owner to renter some time ago, a house from which to extract equity - an essential ingredient for a HELOC - is not readily available.

In this story from CNN/Money, some of the memories came rushing back - how easily the extraction was facilitated by innovative lenders and how giddy the borrower became when the funds showed up in what was previously a humble checking account.

A checking account, that is, not accustomed to numbers with so many digits.

HELOC money seemed to leave as quickly as it came, however, the associated debt had no trouble lingering. But, back in the old days of falling interest rates, you could just refinance the outstanding HELOC balance into a new first mortgage at the new, lower interest rate and your monthly payment would remain the same.

Better yet, sometimes the new payment would go down.

The mortgage balance would increase and there would always be some extra fees that got rolled into the new loan, but no one paid much attention to the new, bigger number representing the new, bigger debt.

It was the monthly payment that mattered.

Ahh ... the good 'ol days.

Things are much different today with interest rates having risen more than four points from the 2003 lows. Back then, there were some nice round numbers to think of when working with HELOCs - $30 a month for $10,000 borrowed was a familiar pair.

Multiply that by three, five, or ten time times and you can have a pretty good party with a pretty low monthly debt service. For example, borrow $50,000 and pay only $150 a month - about one-third or one-half of a typical car payment.

Today in 2006, at roughly twice the interest rate and maybe a couple hundred dollars a month more for energy costs, the HELOC party is getting old. Having come so easily, it was only natural to squander at least a portion of the found money from HELOCs, which makes the higher debt service all the more uncomfortable now.

Never has borrowing against real estate been so easy.

Decades ago, a second mortgage was a sign of trouble, today it is routine.

Ditech.com, one of the very few profitable divisions of General Motors, will always be remembered for their role during this era of easy home equity extraction. An era of easy credit backed by people's homes - something that we will surely find out someday wasn't such a good idea.
For many, HELOCs were like a "gateway" drug - first some pot, then on to the stronger stuff. Enabling that first rush of real estate cash, some never looked back, quickly ratcheting up their standard of living and/or attempting to "double down" by using some of the extracted cash to purchase out-of-state investment property.

Once the extraction began and nothing bad happened, it would often continue. Like an illicit love affair that was at first both strange and dangerous, after a while it all became routine. Time has a way of making things feel normal, when in fact they are anything but normal.

The CNN/Money story tells of how HELOCs are still popular today, even with much higher interest rates. Apparently, lenders now have the crazy idea that you should be able to borrow against the equity in a home before you even purchase the property. This will likely go down as one of the more dangerous lending practices of recent years.

In some high-priced housing markets, according to Ted Gross, a director of the National Association of Mortgage Brokers, people used Helocs to afford pricey homes.

"A lot of people took out Helocs because it's the only way banks would allow them to purchase with less than 20 percent down," says Ellen Bitton, CEO of Park Avenue Mortgage Group.

She explains that some banks would extend a conventional mortgage loan for only 80 percent of the purchase price. Borrowers had to come up with the rest as cash downpayments. The bank would extend a Heloc, which was backed by the equity of the home, for all or a portion of that downpayment.

If that was the only way that banks would allow them to purchase with less than 20 percent down, then there is something seriously wrong with banking these days. The Wall Street Journal had a story just a short time ago about piggy-back loans similar to this having a much higher default rate than other loans.

Should anyone be surprised?

But even at higher interest rates, HELOCs are still popular. For many, it is fast, easy money that they can get today without filling out any more paperwork - what happens tomorrow sometimes doesn't seem that important.

Even though the cost of having a Heloc has soared, their popularity hasn't declined. According to the Federal Deposit Insurance Corporation (FDIC) whose member banks account for a great majority of the Helocs in effect in the United States, the dollar volume of these loans hit $531 billion in March, the last figure available, up 28 percent form $416 billion in June 2004.

According to David Barr, a spokesman for FDIC, homeowners had turned away from refinancing their primary mortgages recently because of higher interest rates. "But they keep turning to Helocs to extract cash from the equity in their homes," he says.

So tempting and satisfying, and no one has to know about it - a little secret between you and your bank. Like the little monkey in the cage hitting the lever to dispense more food, homeowners have been extracting equity online for years now - sitting in their pajamas, in the privacy of their own home.

A home that they own less and less of with each push of the lever.

Like many other aspects of our bubble economy, HELOCs will likely be viewed in retrospect as a terrible idea. It was all good fun when interest rates fell and home prices rose, but with interest rates rising and home prices falling, HELOCs have a completely different feel.

But, many now find that they just can't make ends meet without their HELOC.

There are far fewer options for dealing with the new debt which some people probably thought would never really have to be paid back.

Times change, interest rates rise, and parties come to an end.