Credit Basics
Borrowers move toward fixed rates to limit risk
April 21, 2006
Jim Freer
South Florida Business Journal
Click the remote control and rewind two years and you'll be reminded how banks and other lenders ran barrages of ads urging Americans to tap into the equity of their homes, often at startlingly low starting rates.
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.
