Japan and Russia may be teetering, the Dow may be like a roller coaster, the President may be grouchy from sleeping on the fold-away . . . but as you compile your litany of things to worry about, don’t forget the 125 percent home-equity loans.
You’ve probably seen these babies advertised on TV or elsewhere. Maybe you already have one. They’re currently the hot play in home-finance business, according to Moody’s, the credit-rating people; around $8 billion worth of such loans were outstanding last year; this year it’s up to $15 billion, and rising fast.
Mortgage and consumer-finance companies are jumping into the business with a passion, followed by banks and savings and loans. At the same time, some slightly cooler heads are warning that this type of finance could create big problems later for both borrowers and lenders. “Pretty darned risky” is how Moody’s sums it up.
Here’s the deal: You’re a homeowner with a big credit-card bill, on which you pay a high monthly interest fee — maybe 15 percent or higher. One way to pay that off is to take out an additional mortgage loan on your house, which offers the double advantage of both a lower interest rate and the ability to deduct that interest when you file your income taxes.
Until recently, that only worked if you had a substantial amount of equity in your house. Someone who’d recently put just 10 percent down on a home couldn’t easily pile a home-equity loan on top of the existing 90 percent mortgage.
Now, however, many lenders are willing — nay, eager — to put you into hock up to 25 percent above the value of your home. Ergo, with a $100,000 house and a $90,000 mortgage, you might be able to borrow an additional $35,000, bringing your total debt to $125,000.
To those of us whose love of leverage was lost in the 1980s, this sounds slightly nuts. It doesn’t take a long memory to recall how the last recession wiped out many homeowners’ equity, and you needn’t have a vivid imagination to see how another economic downturn, or even a personal disruption like a layoff or a divorce, could lead quickly to bankruptcy, foreclosure or both.
Multiply those personal calamities by a large enough number, moreover, and you get the makings of an old-fashioned financial crisis: Bad loans force big writeoffs, lenders go insolvent, weak institutions drag down others, and so on. You might recall how something similar led to the savings-and-loan debacle, which cost more than $150 billion.
Are such fears overblown this time? Yes, according to some analysts of the housing industry. Drexel University finance professor Joseph Mason, for one, argues in a recent paper that “high loan-to-value” (HLTV) lending, as it’s called in the trade, actually does just the opposite of what critics fear: It “reduces the costs of consumer credit while promoting the stability of the financial system.”
Mason’s case rests on the idea that lenders are now sophisticated enough to pick only those borrowers who can successfully use 125 percent-type loans, keeping defaults to a manageable level. And consumers who take out such loans to replace credit-card debt will save money, thus improving their financial security, he contends.
“It is not right to view HLTV lending as a `sleazy’ or `reckless’ activity that magnifies consumer lending risk,” Mason wrote.
I’d agree that it’s not a question of morality. The strength of the U.S. financial industry, like the U.S. snack-food industry, is in its genius for letting consumers have whatever they want, whenever and wherever they want it. That’s a fine and noble achievement.
But the fact that there are barbecue chips and gummy bears available 24 hours a day doesn’t make it smart to snack. And having the ability to overindulge in debt doesn’t make it a good idea — either for consumers or for the economy.
