Washington-area lenders are aggressively marketing innovative second-mortgage loans that work as easily as checking accounts, offering low initial interest rates and running slick television ads in hopes of cornering the market on what is expected to be an escalating business in the near future.
Called a home-equity line of credit, these accounts allow qualifying homeowners to borrow against the equity in their homes for any purpose at anytime, including such things as paying for college tuition, home improvements or credit-card bills.
A borrower must qualify for a specific amount of credit, then need only write a check to get a loan. As long as the borrower is below the credit limit, he or she can borrow funds. Payment schedules vary but typically equal 2 percent of the outstanding balance each month. Most equity-credit lines have adjustable interest rates and, depending on the amount of equity in the home, range from $5,000 to $1 million.
"If a customer decides on Friday night that he wants to go on a vacation, he doesn't need to go to the bank to borrow money," said Glenn Sanders, executive vice president for Household Finance Corp., one lender offering an equity-credit line. "With our CheckCredit account, all he does is write out a check. It's more efficient and gives the consumer more flexibility."
The annual dollar volume of second-mortgage lending has tripled since 1980, and is expected to surge next year if proposed tax revision wipes out interest deductions for traditional types of consumer loans, said Perk Lodge, executive director of the National Second Mortgage Association. Lodge said that in 1985, lenders made $75 billion worth of second mortgages and that 23 percent of the outstanding dollar volume of second mortgages is in home-equity lines of credit.
Despite names and advertisements that make such loans sound like credit cards or checking accounts, however, consumer advocates caution that these loans are still second mortgages. Unlike credit cards and other personal loans, which are unsecured, second mortgages are secured against the borrower's home, which could be lost if the borrower defaults on the loan.
"One of the lessons of the Depression was that people shouldn't take out second mortgages for consumer spending or they could lose their house," said Robert J. Hobbs, attorney for the National Consumer Law Center in Boston.
"Consumer aversion to second mortgages continued until the late 1970s, when inflation pushed up housing values," Hobbs said. "The financial industry, which has been trying to shift more and more lending risk onto the consumer, looked at all that value and said, 'This looks like a strong market for secured loans.' Since home-equity lines of credit are usually adjustable rate loans, however, there could be problems if we had a return of high interest rates."
While equity-credit lines are not new, the recent surge in housing appreciation in high-priced cities such as Washington has suddenly given many homeowners a substantial boost in equity, which makes such loans attractive and available.
To take advantage of growing consumer interest, many lenders are offering low teaser rates to attract borrowers, while others are sending out special mailings to homeowners in areas where appreciation has been strong.
To qualify a borrower for home-equity credit, the bank will determine what is about 80 percent of the appraised value of the house and subtract the outstanding amount of the first mortgage on the house. The remainder is roughly what the homeowner could borrow.
Despite initial interest rates as low as 7.5 percent, most of the equity credit lines being offered in the Washington area soon adjust upward to a rate that is 1 1/2 percent above the prime rate, which currently is averaging about 8 percent. Interest is charged only on the amount the borrower has drawn, not the entire credit line.
While those rates usually are lower than credit-card rates, borrowers have to pay closing costs, which average about $400 for a $30,000 credit line, because the loans are mortgages. Banks typically require an appraisal, title search and title insurance, recordation fees and attorney fees as part of the settlement. Most of the lenders do not charge points, origination fees or application fees, but consumers should check each loan program, consumer advocates say.
In an example worked out by Riggs National Bank, a typical Washington family that purchased a home for $70,000 in 1975 could be eligible for about $60,000 in home-equity credit if their house was worth $150,000 today and they still owe $60,000 on their first mortgage.
If they draw $30,000 of their credit line, they would have to pay about $600 a month if their equity line required a 2 percent minimum payment, which is typical. The monthly payment and length of the loan would vary with the interest rate, but would gradually decrease until the loan was paid off, in roughly five to seven years.
"We think this loan is appropriate for today's market because the recent increase in housing values makes it an option for more people," said Lewis Smith, vice president and director of marketing for Riggs. "There is growing appeal among younger people, and, while it takes a little more explaining and better marketing than other personal loans, after the consumer has it, he doesn't have to go back to the bank each time he needs money."
While some lenders are pushing such programs, others are more cautious.
"If you give someone a checkbook with $50,000 worth of checks, they are going to spend it," said one second mortgage lender who does not offer a equity-credit line program and requested anonymity. "It's like letting someone go crazy in a candy store. These credit lines are great for banks but may not be a good idea for the general public."
Donald Irwin, vice president of Loan Depot, a company based in Boston that offers standard second mortgages but not equity credit lines, said that such an account "encourages borrowers to borrow more than they need."
Irwin said that borrowers typically get an equity-credit line for a specific purpose, such as remodeling their kitchen, but end up being qualified for a higher credit line than they need. "Human nature is such that if you give it to them, they are going to spend it," Irwin said.
Michael Lea, chief economist for Federal Home Loan Mortgage Corp., however, said that if lenders are careful in qualifying borrowers, the foreclosure rate on such loans should not be a problem. The delinquency rate on second mortgages last year was lower than for all other mortgage types, except fixed-rate conventional first mortgages, he said.
"I'm not too tolerant of criticism of equity credit lines because it gives the impression that borrowers don't have any sense," Lea said.
In qualifying borrowers, lenders usually do a full credit check and verify employment. Many also place a 40-to-45 percent cap on a borrower's monthly payments for all debts in relation to their gross income, although consumer advocates say those limits are considerably higher than traditional debt limits of between 30 and 35 percent.
Some lenders also include an annual cap on interest rate increases for the loan, typically 2 percent. Other lenders may only approve the credit line if the borrower could qualify for the amount should the interest rate reach 16 percent.
Consumer advocates also warn that many lenders include a statement in their equity-credit line agreement that gives the lender the right to change any term of the loan, including interest rates and payback schedules, with only 15 to 30 days' notice to the borrower.
Despite consumer advocates' concerns that increased second-mortgage borrowing could lead to increased foreclosures, sources on Capitol Hill said that few lawmakers are concerned about tax proposals that would encourage some borrowers to turn to second mortgages.