Executives at Wainwright Bank in Boston say borrowers seem to favor fixed-rate home equity loans over home equity lines of credit in the current housing market and interest-rate environment.
A slumping housing market has slowed the number of purchase mortgages banks and other lenders are originating, but the real estate correction may be affecting another lending sector, as well – home equity loans.
Consumer lending – including home equity, auto and student loans – makes up a sizable chunk of banks’ loan portfolios, about 10 percent both nationally and at local banks. Home equity loans represent the vast majority of that number, dwarfed in dollar volume only by mortgages when they’re tallied in the same pool.
Massachusetts bankers say they expect home equity to remain a solid and reliable type of loan to offer, based on the fact that borrowers who own homes tend to be good risks by definition. But new and shifting market factors may affect demand for such loans, industry insiders say.
The Consumer Bankers Association’s 2006 Home Equity Lending Study, and conversations with local lenders and consultants, offer a snapshot into today’s home equity lending world – and what lenders can expect in tomorrow’s.
CBA’s national study, which surveyed 46 U.S. home equity lenders – more than half with assets of $11 billion or greater – regarding loan trends over the fiscal year ending June 30, suggests a recent slowdown, or at least flattening, in the demand for new home equity accounts.
“[Credit] line accounts and dollars appear to be trending downward,” according to the study, although its figures showed that new home equity account bookings of all types fell about 5 percent, nationwide, this year.
Study editor Fritz Elmendorf of Arlington, Va.-based CBA said loan growth had been tied to “the housing boom” and years of relatively low interest rates.
“But the boom is over,” he said. “Housing prices got inflated, people borrowed against that Â… so where are we now?”
So far, he said, lenders haven’t seen any decrease in the creditworthiness of new borrowers.
No Certainties
CBA survey responses showed new lines of credit bookings, dropped for the third year in a row, but new home equity loan account bookings “experienced a significant increase” of 54 percent. Home equity credit lines function in similar fashion to a credit card, but with a credit limit based on the home and mortgage value. The average size of new home equity lines consumers took at CBA’s responding institutions rose 12 percent, from $75,984 to $84,813. New home equity loan sizes also increased, from $50,709 last year to $57,786 this year. Elmendorf said lenders continue to see customers with high credit scores (“anything above 700 is considered very good,” one Massachusetts banker said). But, Elmendorf said, some banks and non-bank loan companies have started making more subprime loans to customers with lower scores. That, he said, ultimately could make home equity lending riskier, as well. Foreclosures remain “uncommon” on home equity loans, he said. But subprime first-mortgage loans and riskier loans such as pay-option adjustable-rate mortgages could lead to more foreclosures.
“By nature, a home equity loan is a second mortgage. It gets paid off after the first mortgage. So, there’s risk in the home equity business relating to what’s gone on in the first-mortgage market,” Elmendorf said.
On the local scene, executives at community banks such the $950 million-asset South Shore Savings Bank in Weymouth, Hingham Institution for Savings, which has $684 million in assets, and Boston-based Wainwright Bank, an $800 million-asset institution, said home equity loans are gaining popularity at the expense of lines of credit in the current uncertain interest-rate environment.
As is the case nationally, representatives of all three banks said home equity loans make up about 10 percent of their total portfolios.
First mortgages and commercial lending account for the remaining 90 percent.
Chris Dunn, senior vice president and senior residential lending officer at South Shore Savings, suggested that one particular type of loan may be driving some of the Massachusetts home equity market.
“There has been a tremendous amount of [home equity] financing in the purchase market,” he said. He said that some lenders have been offering so-called 80/20 mortgage loans, in which the major part of the loan, 80 percent, is a traditional mortgage, and the lesser part, usually 20 percent, is a higher-rate second mortgage. That type of loan can be made attractive to consumers who want to avoid paying private mortgage insurance, or PMI, a cost lenders often ask borrowers to pay if they are not making a down payment of 20 percent on a house, Dunn said. The smaller, 20 percent loan is considered an equity loan.
“Real estate and mortgage brokers tout this as a way of getting around PMI,” he said. “It’s been one of the major, major pushes by the mortgage brokers and some mortgage bankers. It has been a major part of their originations. In the last few years, it’s become increasingly common as a means of financing the purchase of property.”
South Shore Savings doesn’t offer that type of loan, Dunn said. Neither does Wainwright Bank, said Senior Vice President for Consumer Banking Steven F. Young. But Young agreed that 80/20 mortgage loans “have become very popular in Boston,” especially in the past four to five years, because of high home prices. Wainwright does offer a city-sponsored “soft second mortgage” program in which the second mortgage is subsidized in order to assist low- and moderate-income homebuyers, Young said.
Dunn noted that his bank recently received word, from a company that issues private mortgage insurance, that PMI is expected to become tax-deductible for certain homebuyers next year.
“That might have a further impact on the whole 80/20 business,” he said. “It would be better, I think, for the consumer overall,” added Hingham Institution for Savings Vice President for Retail Lending Michael J. Sinclair. Hingham Savings also does not offer the 80/20 loan.
Making PMI tax deductible would put it in the same category as mortgages and home equity loans, on which interest payments are generally tax deductible.
While changes in the real estate market are having at least some effect on home equity lending, Sinclair said he hasn’t seen a significant change in the kind of borrower seeking such loans. He expects loan volume to remain constant this year.
“Credit scores remain at the higher end,” he said. And people are coming in for the same reasons: End-of-the-year financial checkups sometimes reveal a need for more cash.
Young said that Wainwright has been seeing more requests for fixed-rate home equity loans (as opposed to variable-rate lines of credit), which he believes is due to consumers’ uncertainty about whether interest rates will go up or down. Dunn said his bank’s experience is similar.
In addition to debt consolidation, home equity borrowing remains strongly tied to home improvement spending. A Harvard University study released this fall showed a sharp decline in the number of people conducting home improvements across the United States, a recent trend that is likely to decrease demand for home equity loans going forward.
Young said he doesn’t think home values are going to drop further, but the direction in which interest rates are headed remains a question with which borrowers are wrestling.
“I think that consumers think interest rates will go up, so they’re applying for a loan,” Young said. “But now, that’s not a certainty.”
