Mar312016

Homeowners deduct cheap consumer debt interest while renters pay higher rates

Homeowners convert consumer debt into tax-deductible debt through home equity lines of credit. Since this debt is secured by real estate, homeowners also pay much less for it.

hell_to_payHELOCs are making a comeback! This is great news for Ponzis who want free money from stupid lenders, but it’s a dangerous warning for all of us who supplied taxpayer bailout money to the stupid bankers who gave out free money last time.

With rates hovering near record lows, and with banks desperate to loan money, banks are offering those with good credit very favorable terms on helocs — and borrowers take the free money. Ten years ago heloc lending was an open invitation to theft for millions of borrowers running personal Ponzi schemes. Since lenders confidence in helocs rises with house prices, and since lenders believe their high FICO score borrowers won’t burn them, lenders are willing to risk reigniting the mania 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.

One of the most galling features of heloc borrowing is the gross unfairness of its implementation. Obtaining a home equity line of credit requires owning a home, which means 40% of Americans simply don’t have access to this money at all. Further, it requires having enough equity in the home so that the total indebtedness is less than 80% (or 90% with some lenders) of the total home value. This eliminates another 20% or more of Americans. That leaves this potential benefit available to a minority of the American people.

So what? Who cares if these loans are only available to a small minority?

Well, if these were private loans without any government subsidies, I probably wouldn’t care, but that’s not what these are. The interest paid on helocs up to $100,000 are completely tax deductible.hungry-homeowners In other words, those of us who don’t have helocs subsidize those that do. In addition, heloc borrowers obtain very favorable interest rates. While renters often pay 10% or more on credit card debt, heloc borrowers often pay less than 5%, and they get the tax break.

Is heloc borrowing so desirable that the rest of us should pay for it?

I don’t think so.

Banks Ramp Up Push for Home-Equity Lines

By Daniel McDonald – March 28, 2016

As the broader mortgage market remains in the doldrums, banks are again touting home-equity lines of credit, …
Lenders are betting that offers for home-equity lines of credit, or helocs, will resonate with many borrowers whose home values are higher than they were just a couple of years ago and who need cash for renovations or other expenses after holding on to their homes for longer than expected.

HELOC_MoreOr other expenses? What do you suppose those would be?

HELOC abusers were easy to spot back in 2005 and 2006. It’s relatively easy to evaluate general level of income in a neighborhood by the quality of the houses and the cars in the driveway. It was common to see two new luxury cars in the driveway even in less affluent neighborhoods, a classic sign of HELOC abuse. Most people would park their luxury cars in the garage, but if the garage is full of useless crap bought with HELOC money, the owners would be forced to park their fancy cars outside. Some may not have had garages full of HELOC booty, merely parking their fancy cars outside to show off to the neighbors.

Lenders extended just over $156 billion in home-equity lines of credit last year, the largest dollar amount since 2007, the beginning of the housing bust…. That marks a 24% increase from 2014 and a 138% spike from 2010 when new approvals hit a low point.

The average line amount extended to homeowners last year reached a record $119,790, according to the firm, which tracks the data back to 2002.

Lenders are opening up their spigots,” said Sam Khater, deputy chief economist at CoreLogic. …

I doubt we witness the same level of Ponzi theft this time around. During the housing bubble, lenders offered borrowers the ability to refinance at lower interest rates, allowing 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, future heloc borrowers won’t enjoy lower interest rates to refinance and keep the same monthly payment; therefore, HELOC booty will have a cost this time. If the borrowed money has a real cost, far fewer people will take it–and those borrowers won’t extract nearly as much money due to qualification barriers. Borrowers can no longer fabricate an income number to justify the loan, curtailing Ponzi borrowing, which inevitably leads to a crash.

The push from banks marks a reversal of strategy for many of them. Lenders scaled back on giving out second liens in the wake of the housing downturn, and many cut existing credit lines to avoid new defaults. Some lenders exited the home-equity lending market entirely. …

J.P. Morgan Chase & Co. began reaching out to customers in January about the benefits of cash-out refinances, saying the move is often a smart way to tackle home repairs, debt consolidation and tuition payments. The campaign is a first for the bank, said a spokeswoman.

We will 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’s 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, which many people do anyway.

Home-equity lines can be risky because they generally have variable interest rates, which could rise, leading to larger monthly payments for borrowers. Many home-equity lines are also structured in a way that allows borrowers to put off principal payments for the first 10 years. Once principal is due, payments can jump by hundreds or thousands of dollars. For banks, these payment shocks could lead to an increase in delinquencies many years after they have given out the loans.

housing_martyrOver the last several years, as loans reset, the interest rates were lower, so the reset didn’t cause a problem. However, many of these loans also recast, which means they converted from interest-only to amortizing loans. The recasting loans all require much higher payments, unless the lender kicks the can. Ten years from now when the current crop of helocs is due to reset or recast, interest rates will likely be higher, and many borrowers will endure jarring payment shocks. (See: 250,000 HELOCs due to recast in Orange and LA Counties)

Lenders are requiring higher credit scores this time around, and in most cases borrowers must have at least 20% equity left in their home after receiving the credit line. The average weighted FICO score for borrowers who received a home-equity line in the fourth quarter of 2015 was 781, on a scale that ranges from 300 to 850, compared with 742 for the same period in 2005, according to Black Knight Financial Services, a mortgage-data firm.

Vicki Boddy and her husband, Mike, received a $125,000 home-equity line of credit from J.P. Morgan in February, after their home was appraised at $447,000.

The Boddys have lived in the same home in Kenmore, Wash., for the past 23 years. They wanted to renovate the kitchen and other parts of the home, and chose to borrow rather than use savings to pay for it.

“Having the heloc means we can use the money in savings for reserves and a vacation to go visit our kids,” she said.

Notice how easily people forget the money is fungible, meaning it can be easily interchanged with other uses. While this couple may indeed spend the heloc on home improvements, this loan freed up capital that they can then spend on consumer goods like vacations. How is that different in any way from the spendthrift who uses that heloc money directly to buy consumer goods? Obviously, it isn’t any different. And as a taxpayer, I find it outrageous that we subsidize consumer spending this way.

WhereDidAllTheHELOCGo

Promoting heloc abuse is no different today than it was ten years ago when everyone lost their minds — and later their houses. It was foolish then, and it’s foolish now, making a government subsidy for this behavior a travesty.

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