Much of the trouble that the housing bubble eventually caused didn't come directly from the stratospheric rise and subsequent meteoric fall of home prices. Rather, it came from the ability of homeowners to tap their sudden increases in home equity rapidly and efficiently through home equity loans and lines of credit. The ease with which one could borrow up to and sometimes in excess of the entire amount of equity you had in your home coined the term "housing ATM."
After a sudden halt to home equity activity during the financial crisis, homeowners have struggled over the past several years to build up any equity in their homes. Yet now, with home prices having hit bottom in some markets and with homeowners having had a few years to pay down debt, equity is suddenly available again -- and borrowers are increasingly taking steps to tap it.
They're back, baby!
As banks have been reporting fourth-quarter results over the past couple of weeks, they've shown higher levels of activity in the home equity space. Toronto-Dominion's (NYSE:TD) TD Bank, M&T Bank (NYSE:MTB), and JPMorgan Chase (NYSE:JPM) were among banks showing substantial increases, with JPMorgan posting a jump of 35% in home equity lines of credit during the quarter to $373 million in originations. TD Bank said that the number of home equity originations jumped 27%, while M&T's dollar volume of originations saw similar gains.
Overall, though, homeowners have been more interested in locking in low rates via home equity loans rather than accepting the variable rates that most home equity lines of credit offer. That's likely because fixed rates are so low that you don't get much benefit from accepting the risk that a variable-rate line of credit involves. TD Bank, Wells Fargo (NYSE:WFC), and other banks have had to add ways to convert part or all of their home equity lines into fixed-rate loans in order to entice borrowers.
How to stay prudent
Just because home equity loans are available with attractive rates doesn't mean that you should go out and grab one yourself. In fact, even if you want one, you may find you can't get a loan.
Unlike mortgage loans, which banks can package and sell to Fannie Mae or Freddie Mac for eventual securitization as mortgage-backed securities, home equity loans and lines of credit typically remain assets of the bank that originated them. As a result, banks have a far greater incentive to ensure that their quality is as high as possible, and that means requiring more information and maintaining stricter guidelines even than what Fannie and Freddie now want for traditional mortgages.
Still, you may find it makes sense to try to go the home equity route. For one thing, origination costs are often far lower for home equity arrangements than for full-blown mortgages, with many banks willing to pick up fees for appraisals and other closing costs in exchange for a commitment not to close the line or pay off the loan within a certain number of years. Moreover, the process can be simpler than for a mortgage, resulting in faster turnaround times for those who qualify.
Most important, it's essential that you understand how interest rates work on the loans. For lines of credit, find out which interest rate your line's finance charges are based on, and how quickly your rate may go up if that benchmark starts to rise. For home equity loans, make sure you're comfortable that you'll be able to make monthly payments and repay any balloon amount outstanding at maturity. With either type of home equity borrowing, leaving yourself open to refinancing risk down the road is a bad idea, given that the 10-year Treasury's yield has hit the 2% level and could see further increases.
Don't get stuck again
Ten years ago, after the tech bust, bumper stickers in Silicon Valley had pleas for just one more bubble. Homeowners may be wishing the same thing, but that doesn't mean you should go back to using your home as an ATM again. Be more prudent with your home equity, and it can serve you well as a valuable tool rather than a catalyst to serious financial trouble.