Credit Basics
Borrowers Move Toward Fixed Rates To Limit Risk
Friday, April 21, 2006
Jim Freer
The South Florida Business Journal
Return to today's reality and you'll find numbers that show how eagerly South Floridians and other Americans took those offers for home equity lines of credit, also known as HELOCs. You'll also see how rising interest rates have made the debt owed on HELOCs a big part of the country's growing financial squeeze. With mortgages still fairly low by historical standards, some borrowers with HELOCs or adjustable-rate first mortgages are refinancing with fixed-rate mortgages to minimize the risk of future rate increase. Sometimes they combine both an adjustable-rate mortgage and a HELOC into one new fixed-rate mortgage.
Bankrate.com reported April 12 that the average 30-year, fixed-rate mortgage was 6.56 percent, which means those with solid credit scores can probably get under one for less than 6.5 percent. The 30-year average is up 1.3 percentage points from a low of 5.28 percent in 2003.
Converting to a fixed rate can leave a homeowner with one monthly payment and a certainty of the rate, said Sean Donahue, VP of sales in mortgage banker HomeBanc's Deerfield Beach office. "We are seeing an increase in that business," he said. As interest rates rise, HELOC holders should put extra focus on drawing out money only when essential, treating it like an emergency backup, said John Takacsy, senior manager for consumer lending at RBC Centura Bank in Raleigh, N.C.
Borrowers should try to pay off all or part of a balance, with a year-end bonus or tax refund money, added Takacsy, whose bank has about 15 South Florida branches. In a HELOC, a borrower has access to a portion of the built-up equity in a home. A borrower is required to pay minimum interest each month, with a final date for repaying the full amount taken out on the credit line.
Those features have made HELOCs more popular than home equity loans. In those loans, a homeowner borrows a sum that is part of built-up equity and makes a monthly payment similar to a traditional mortgage.
The banking industry's holdings of HELOCs has grown from $256 billion at the end of 2002 to $534 billion at the end of last year, according to the Federal Deposit Insurance. Corp. The FDIC does not have data on the number of HELOCs. At banks based in South Florida, HELOCs grew from $1.4 billion to $2.8 billion during the four years.
Swapping credit card debt
One reason behind the doubling of HELOC dollars is that several million U.S. households traded in unsecured debt, including credit cards, for secured debt backed by their homes, said Howard Dvorkin, founder of Consolidated Credit Counseling in Fort Lauderdale.
A HELOC, like a traditional mortgage, also offers the advantage that tax-deductible interest payments.
But many Americans could soon find they have "put their houses up as bargaining chips" if rising costs for housing and other expenses make it difficult to pay those loans and other bills, Dvorkin said.
Consolidated Credit is receiving about 1,500 calls a day from Americans seeking advice on repaying debt. That is about double last year's rate.
The company does not have a precise number on calls that include HELOC questions. But Dvorkin said those calls are increasing.
Data from the FDIC shows the banking industry's delinquencies on HELOCs have remained at relatively low levels this year. But the FDIC and other regulators are concerned that loose HELOC underwriting standards by some banks, particularly amid the past two years' rise in some key interest rates, could lead to an increase in delinquencies.
In a guidance issued last May, regulators told banks to increase their monitoring of HELOC borrowers' credit history and other debts and to be more conservative on the size of credit lines. Rates on HELOCs are adjustable, and most are tied to the prime rate. HELOC rates typically range between 1 percent below and 1 percent above prime, with the peg based largely on a borrower's credit history.
In a series of increases between June 2004 and March 28, the Federal Reserve raised its federal funds rate from 1 percent to 4.7.5 percent. Banks raised their corresponding prime rate from 4 percent to 7.75 percent. Between March 2004 and late last month, the national average rate on HELOCs rose from 4.64 percent to 7.66 percent, according to North Palm Beach-based Bankrate.com. For a borrower with a balance of $20,000, the minimum monthly interest payment has increased from $77.33 to $127.67.
Payments will keep growing if the prime rate continues to rise to 8.25 percent by this summer, as many economists expect, said Greg McBride, senior financial analyst at Bankrate.com.
Teaser rates expiring
Many HELOC borrowers have adjustable-rate mortgages, some that were interest only, which they took out at teaser rates three or five years ago. This year, many of those loans are beginning ongoing annual adjustments - in some cases with a first jump 3 percent or more than the original rate.
"There are a lot of households who, two years ago, took out a home equity line to remodel a kitchen or make other improvements, when rates were low," McBride said. Thus, many Americans are facing interest payments twice as high on HELOCs, along with other rising interest rates and higher costs for insurance and gas, he said.
The surge in HELOCs is among reasons total U.S. consumer debt rose from $1.9 trillion at the end of 2002 to $2.2 trillion at the end of last year.
When borrowers can't control HELOC debt, Consolidated Credit helps them prepare for other options. That includes refinancing and ways to reduce overall spending. Dvorkin is concerned that "we may be just at the tip of the iceberg" with problems related to HELOC and other mortgage debt.
For several years, many South Floridians could resolve debt problems by selling homes whose values had soared, he said. This year, the pace of appreciation is returning to more historical levels. "If values retreat, some people could find their homes worth less than what they owe" possibly leading to an increase in foreclosures, Dvorkin said.
No red flag for banks
Data from the FDIC shows that severe problems with HELOCs are still below the 1 percent level regulators consider troublesome. The national non-current rate for HELOCs grew from 0.18 percent at the end of 2004 to 0.24 percent at the end of last year. Non-current loans and credit lines are 90 days or more delinquent or are no longer accruing interest.
Among banks based in South Florida, that rate was 0.17 percent at the end of 2003. It rose to 0.36 percent at the end of 2004 and fell back to 0.18 percent at the end of last year. Northern Trust Bank of Florida and BankAtlantic, the South Florida banks with the most HELOCs, had non-current rates of 0.04 percent and 0.11 percent, respectively.
Northern Trust's client base of business owners and other professionals includes some HELOC borrowers with credit lines of several hundred thousands dollars and more, said Trip Moore, a senior VP in the bank's Palm Beach office. Many borrowers have used HELOCs to pay for children's education, buy cars or second homes, or make investments, he said.
Northern Trust has avoided problems with HELOC repayment because it focuses on borrowers' income, cash flow of business and other "ability to service and repay debt" factors similar to a standard mortgage, Moore said. Some lenders have underwritten HELOCs based largely on built-up equity in homes. "A lot of the concern about HELOCs is because they can be based purely on the value of a home," which can decline as quickly as it once rose, Moore noted.
In a nutshell, that's why HELOCs are a big part of the growing concern about potential problems in local and national real estate markets.
