Feb082016

HELOC abuse rising along with house prices

As house prices rise and more homeowners possess equity again, some are withdrawing this money at low rates and spending it, stimulating the economy.

hungry-homeownersDuring the housing mania, people bought homes because house prices rose rapidly, and lenders gave equity to homeowners at 100%+ of the value set by recent comps. Under such circumstances, houses were very desirable, and it added fuel to the housing mania, and funded millions of personal Ponzi schemes.

Homeowners like mortgage equity withdrawal because it provides them instant access to the free money bestowed upon them by the magic appreciation fairy. Homeowners gladly suspend their disbelieve at the too-good-to-be-true nature of free money, and if lenders willingly dole it out, homeowners eagerly accept it.

Politicians actually encourage mortgage equity withdrawal because reckless spending boosts the economy. Economists coined a pleasant euphemism, the wealth effect, to gloss over the brazen theft that often accompanies this kind of borrowing. Lenders are willing to enable this behavior as long as some other investor is willing to absorb the loss. Fortunately, unlike during the housing bubble, investors aren’t stupid enough to give out free money to Ponzis — at least not yet.

For now, banks are being more conservative in their lending, but since lenders and investors chasing yield may become more aggressive as their confidence in rising house prices increases, rampant HELOC abuse may return. If it does, it could easily reignite the same desires that inflated the housing bubble leading to a painful crash and more taxpayer bailouts. Everyone who doesn’t want to subsidize their neighbors reckless spending should be wary of a return to a HELOC dependent economy and lifestyle.

Owners cautiously taking cash out of homes

Diana Olick, Monday, 1 Feb 2016

Home values are rising and homeowners are taking advantage of that, finally tapping into that equity again in the form of cash-out mortgage refinances. They are doing so, however, by pulling the most conservative amounts in history.

I would love to believe homeowners learned their lessons and the low levels of HELOC abuse are a widespread choice, but that would be wishful thinking. So far, lenders and investors are unwilling to give out free money, so loan-to-value ratios remain reasonable, and underwriting is strict — for now.HELOC_hog

Prior to the historic housing crash of the last decade, homeowners used their homes like ATMs, pulling out as much cash as the bank would allow, which at the time was essentially all of it and more. This led to millions of borrowers falling underwater on their home loans as home prices fell, and leading to 7.1 million homes so far ending up in foreclosure, according to Black Knight Financial Services.

This shows how widespread the mania was. It’s almost inconceivable that so many people could have been so foolish, but they were. Eighty percent or more of those foreclosures would have been avoided if people hadn’t run up excessive mortgage debt. The faltering economy is falsely blamed for the problem. The real root was excessive indebtedness due to millions of people running personal Ponzi schemes based on HELOC debt. Everyone became a HELOC hog, and they were led to slaughter.

Lending standards have tightened significantly since then, but borrowers are clearly much more risk averse. They are taking cash out again; 42 percent of mortgage refinances last fall involved borrowers taking cash out of their homes, not just lowering their interest rates. That is the highest share since 2008, according to Black Knight.

The average cash-out amount was over $60,000, but the average loan-to-value ratio after the refinance was 67 percent, the lowest level on record. Borrowers left 33 percent equity still in the home.

Sixty thousand dollars is no small sum. That’s more than a year’s take-home pay for the average worker, two years’ worth in some areas.pay_our_debts

All totaled, there was $64 billion in equity tapped via cash-out refinances over the past 12 months, the highest dollar amount for any equivalent 12-month period since 2008-2009,” said Ben Graboske, Black Knight senior vice president.

“Even so, this amounted to less than 2 percent of available equity being tapped. This is slightly below the post-crisis norm, and 80 percent less than the total amount of equity extracted from the market in 2005-2006.”

Eighty percent less than 2005-2006. That doesn’t make today’s borrowers any more prudent, it underscores how widespread the disease was during the mania.

“The people that are transacting have passed the credit screens. Borrowers are taking out what they need. It’s the mindset right now. Use what you need and not more,” said Graboske. “The only other explanation would be a lender level credit overlay, but these levels would be unprecedented. There is definitely money being left on the table.”

HELOC_needed

It doesn’t take long for people to lower the standard for defining what they need to begin encompassing things they just want.

“The memories are seared in people’s minds who went through it. They’re getting more comfortable with a lower debt rate. It’s turning into a secular change in behavior in saving for a rainy day,” said Peter Boockvar, chief market analyst at the Lindsey Group. …

I hope he’s right, but I rather doubt it.

Realistically, the only reason we have less HELOC abuse today is because those who were the worst offenders were weeded out during the bust, and nobody is willing to give them free money today. Those homeowners with equity were largely the survivors who didn’t take the free money 10 years ago, so they aren’t about to take it now.

Borrowers who do take out home equity loans today … take out fully amortizing home equity loans. That means they start paying it back immediately with monthly principal payments on top of interest.

When money isn’t free, people have less of an appetite for it.

middle-class1

Will HELOC abuse come back in full force?

I don’t think we will see the same level of theft we witnessed last time around. During the housing bubble, lenders offered borrowers the ability to refinance at lower interest rates. This allowed borrowers to extract their equity often without increasing their monthly payments. From a borrower’s perspective, this really was free money.

Since we are at the bottom of the interest rate cycle, borrowers won’t get lower interest rates to refinance and keep the same monthly payment, so HELOC booty will have a cost this time around. If the borrowed money has a real cost, far fewer people will take it, and those that do won’t be able to extract near as much because they will face qualification barriers. That should curtail Ponzi borrowing which is the behavior that inevitably leads to a crash.HELOC_hangover

We will almost certainly see a continuation of debt consolidation loans on HELOCs. It makes sense financially to consolidate high-interest credit card debt on a low-interest HELOC; however, it is foolish to run up the credit card debt in the first place. Financing short-term consumption with long-term debt is never a good idea. Debt consolidation is a one-time fix for those who see the light and stop using their credit cards. It’s a terrible way to routinely plan finances.

I think most HELOC money in the future will go toward debt consolidation and home improvements, a tolerable though foolish use of consumer debt. At least for how the repugnant conspicuous consumerism on borrowed money is a relic of the housing mania. Let’s hope it stays that way.

https://www.youtube.com/watch?v=0axQ7w-f8RE

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