JAMES F. FLYNN
‘A safety net’
There is one upside to the high home values in the commonwealth for lenders and homeowners: They pave the way for home equity loans or credit lines. A recent study suggests that 55 percent of Boston-area homeowners have taken advantage of a home equity loan or line of credit, significantly more than the 42 percent reported to have used such products nationwide.
But the region’s rapid home price gains, which have enabled so many borrowers access to loans at favorable rates, may not be immune to the market corrections that have hit so many other economic sectors. For those who believe that what goes up must come down, questions about whether a bursting real estate price bubble could force large numbers of home equity borrowers into foreclosure, devastate neighborhoods and put some lenders out of business loom.
While such dangers may exist, the consensus in the mortgage industry is that home equity products remain valuable tools for owners in need of cash. James F. Flynn, president of Marathon Mortgage in Hopkinton and president of the Massachusetts Mortgage Association, said a home equity loan is still a very good vehicle for homeowners who want to buy a car, pay for education costs or consolidate debt.
“It’s a safety net,” Flynn said.
Home equity loans and credit lines generally have a shorter term than first mortgages. Equity loans typically last between five and 15 years.
A home equity loan is a one-time lump sum that a borrower pays off over a set period of time using home equity as collateral. It has a fixed interest rate which is typically lower than other loans because it is secured by the home.
However, a credit line allows someone to borrow money for a certain period of time set by the lender. During that period, a borrower can withdraw money as needed. Similar to a credit card, as a borrower pays off the principal, credit revolves and can be used again. This type of loan has a variable interest rate that also typically is lower than similar products because it is secured by the borrower’s home equity.
Charlie Nilsen, regional executive vice president at Gateway Funding in Woburn, said that although large numbers of Bay State homeowners have taken out home equity loans and credit lines, the market has not yet been tapped out because home values continue to appreciate.
A growing number of home equity loans or credit lines are being requested at the time someone purchases a home. Nilsen said borrowers may provide a 20 percent to 30 percent down payment and take 10 percent to 20 percent out of the purchase price for a line of credit simply for peace of mind or future plans.
Flynn noted that it has been a banner year for home purchases and equity loans remain popular “because values are up.”
Linda Bates, senior executive vice president at Sherwood Mortgage in Boston, said the refinance boom is one reason home equity loans and credit lines are popular right now.
Many borrowers have a first mortgage at a low rate and, while rates have ticked up, borrowers still have costs for cars, college or debt consolidation. Instead of refinancing again at a higher rate, borrowers can take advantage of equity in their homes.
While the rate on an equity loan can be slightly higher than a rate on a first mortgage, many find the equity loans or credit lines more cost effective when paying off large debts because the rates are lower than those of a credit card or car loan.
Bates predicted that if fixed mortgage rates begin to climb sharply, home equity loans will become increasingly popular.
John Brodrick, president at First Service Home Mortgage in Westwood, said his company is also doing a fair number of home equity loans in conjunction with home purchases. He points out that not every homeowner draws from the line of credit immediately and many simply use them as a “security blanket.”
Lessons Learned
But what happens to lenders and homeowners who have tapped the equity in their homes if home prices suddenly decrease and borrowers owe more than their house is worth? Industry insiders say while prices could drop, the days of rampant foreclosures and empty neighborhoods seen in past real estate cycles are long gone.
Flynn said people are slightly nervous about the potential for dropping home prices and the consequences, but people have learned from the past.
“People are being a little more cautious,” said Flynn. “They are remembering the [late] 1980s and [early] 1990s when we had a depressed market.”
Sales have been taking a little longer and the market may be softening, but the deeply distressed housing situation of the early 1990s was a “one-time deal,” Flynn said.
The number of new homes being built is well below what was built in the 1980s, Flynn said. He said banks and builders are more astute and builders are selling homes before they build them.
Bates said home prices would likely decrease if interest rates rose steadily, however, she points out that rates are climbing from 40-year lows and current rates are still considered extremely low from a historical viewpoint. She doesn’t expect a scenario such as what occurred in the 1980s and 1990s to occur again.
“Anything can happen,” said Bates. “[But] we learned our lessons from that time period.”
Appraisers have been cautious, as well, Bates said.
Nilsen also doesn’t expect a repeat of the 1980s and 1990s. He said people buying homes in that time period speculated that values would increase and instead they dropped. While home prices have escalated recently, speculative buying today is not nearly as common as it was during the real estate boom of the early and mid-1980s.
There are the optimists like John Urbanchuk, director of Pennsylvania-based LECG, a leading economics consulting group, who said he is not convinced there is a real estate bubble to burst. There has been a consistent increase in house values and while prices recently have stabilized slightly, he said he doesn’t anticipate a huge change in values. He said demand is outstripping supply therefore keeping prices on the high side.
But if things change and home prices drop, Flynn said there is that potential risk that some lenders could close their doors.
There is always the risk that home values could depreciate and borrowers could walk away from their devalued homes and repayment commitments, Despite the risks, lenders continue to offer equity loans because of their profitability. Nilsen said the interest rates on home equity loans or credit lines, which are generally higher than first mortgage interest rates, provide lenders with significant income.
Brodrick said it does not appear that the real estate bubble will burst in the near future, but lenders must always consider the risks and behavior of past markets.
The risk lessens, of course, when a lender regularly sells loans to an investor, like First Service Home Mortgage does.
Bates said lenders also remain cautious and have tightened their underwriting standards, mitigating the risk of a wave of loan defaults and foreclosures should the real estate market dip.
In order to prepare for a potentially depressed market, Bates said the mortgage industry must “police” itself and perhaps not be as liberal in their underwriting as they were in the past.
Flynn said people will become wary if the Federal Reserve raises short-term interest rates, as Chairman Alan Greenspan has warned, because lines of credit have variable interest rates.
However, according to a study conducted by International Communications Research and released by Champion Mortgage, a division of Cleveland-based Key Bank, 67 percent of Boston-area homeowners indicated that a slight increase in interest rates would not have an impact on their willingness to apply for a new home equity loan or line of credit.
The study found that 19 percent of Boston-area homeowners used the term loans or credit lines to pay off credit card bills, another 19 percent consolidated outstanding debt and 57 percent or respondents used the loans and credit lines for home improvements.
Urbanchuk said there is still a market out there for home loans despite rising rates.
“Consumers are completely aware and understand rates are rising,” he said.
