Remember home equity loans? Or before it became Un-Politically Correct to call them that, second mortgages? Like the ghosts in the movie Poltergeist II, theyyyy’rrreee baaaccckkkk!
So notes this morning’s Wall Street Journal, cheerfully proclaiming:
“A rebound in house prices and near-record-low interest rates are prompting homeowners to borrow against their properties, marking the return of a practice that was all the rage before the financial crisis.”
The story goes on to note that home equity lending hit $59 billion last year, the highest level (excluding the housing bubble years) since 2000. The most popular product? A “HELOC” or Home Equity Line of Credit.
I have years of experience tracking these puppies. Rather than give you a fixed amount of money for a fixed amount of time all at once, HELOCs are revolving-style loans that can be drawn upon as needed via credit cards or checks.
You typically have a draw period of, say, 10 years. Your interest rate fluctuates along with market rates during that time. At the end of the draw period, you can no longer take additional advances and, instead, have to pay the remaining balance off over a period of a few more years.
“These are the kinds of products that helped blow up the entire banking industry.”
HELOC volume at Bank of America (BAC, Weiss Rating: A) surged 77 percent year-over-year in the first quarter, according to the Journal. Wells Fargo & Co. (WFC, Weiss Rating: A+) reports strong volume as well, while EverBank (EVER, Weiss Rating: B+) is going to start offering HELOCs for the first time since 2007 this month.
The bad news? These are the kinds of products that helped blow up the entire banking industry.
People borrowed up to 100 percent of their homes’ values as prices spiraled higher. They used that money for everything from more legitimate purposes, like funding home improvements, to more reckless things, like paying for vacations and flat-screen TVs.
|Would you borrow against your house in this environment?|
Rather than put down any money to buy homes, many Americans also used home equity loans as part of 80-20 “piggyback” mortgage financing structures. In other words, rather than put 20 percent down in cash and take out a first mortgage for the remaining 80 percent of a home’s purchase price, a borrower would take out a second mortgage for the 20 percent and a first mortgage for the 80 percent. That meant many borrowers had essentially no skin in the game, and they subsequently walked away in droves when home prices plunged.
Now, bank execs will tell you it’s different this time. They’ll say they’re only lending up to 80-85 percent of a home’s value, that they’ll only do loans on owner-occupied properties (rather than investment homes), and that they’ll only extend credit to borrowers with tip-top credit scores.
But if home prices have been artificially inflated recently, thanks to the “Echo Bubble” process I’ve described, will that matter? Or are we just getting into a scenario where Americans are borrowing against artificially inflated assets … again? Then when asset prices deflate, they’ll be hung out to dry … again?
Would you borrow against your house in this environment? Do you think the tax benefits and relatively low costs of home equity loans outweigh the potential downside? And what is the broader message here from the revival of home equity lending? Are banks taking on too much risk … or is this a welcome loosening of credit standards for the economy? Hop on over to the blog and let me know!
|OUR READERS SPEAK|
Meanwhile, many of you sounded off about the split between the real economy and the markets. Reader Mark said the stock market will inevitably run out of steam unless the economy plays catch up. His comments:
“A market where only the stockholders profit is not a long-term solution, and we are starting to see it unravel before our eyes. You simply can’t keep cutting jobs and expect the economy to improve. The beginning of any economic engine starts with consumption, and if people don’t have money with which to consume goods, the economy will come to a halt.”
Reader Rick A. agreed, saying that central banks are trying to interfere with long-term economic cycles — a battle they’re destined to lose. His forecast?
“The Fed is simply interfering with capitalism, just as Japan’s central bank has done for the past 20 years … look out below! … I see another real estate slide and stock market retracement soon unfortunately.”
On the other hand, Reader Robert G. said he thinks that we will get out of this mess and get back on track once we see political change in Washington — and that stocks are the best asset in this environment. His view:
“I believe the market knows we will get out of this mess and the American engine will roll again when we get a new administration. So we are currently marking time. We have a lot of money on the sidelines just waiting to be put to work, but business does not feel comfortable with the way we are being taken by our current government.
“There is no place to put money today to earn any kind of a return except the stock market. We will continue to invest in the market and keep setting new highs. Only a major disaster or something like 911 will cause a major correction.”
Interesting thoughts all around. Personally, I’ve been recommending several stocks that are in their own “private bull markets” in sectors like domestic energy, aerospace, and health care. They have worked out very well. But with volatility collapsing and complacency running rampant, I’m definitely getting more nervous about stocks.
If you have any additional thoughts, please don’t hesitate to share ’em here .
|OTHER DEVELOPMENTS OF THE DAY|
The former CEO of Microsoft (MSFT, Weiss Rating: A), Steve Ballmer, is reportedly going to buy the Los Angeles Clippers for around $2 billion. That should bring the sorry saga of Donald Sterling’s ownership to an end, assuming the NBA and other parties can agree to terms.
We’re going to dine on a ton of very important economic data next week. But we got a couple of appetizers today. Personal spending slipped 0.1 percent in April, or 0.3 percent once you adjust for inflation. That inflation-adjusted drop was the biggest since September 2009!
At the same time, a consumer sentiment indicator rose to 81.9 in May from 81.8 a month earlier. And an index of Chicago-area manufacturing jumped to 65.5 in May, against forecasts for a reading of 60.3.
I’m scared of heights. But on one of my first dates with my Chicago-born wife, Kim, I braved the “Ledge” attraction at the Willis Tower (or Sears Tower, as Chicagoans still call it). It’s a series of reinforced glass boxes that protrude from the 103rd floor — allowing you to look out or straight down to the street hundreds of feet below.
Lo and behold, a protective layer of material that covers the underlying glass shattered when some tourists visited the other day. This is what it looked like. Yikes! I don’t think Kim will get me out there again anytime soon.
Reminder: If you have any thoughts to share on these market events, all you have to do is hop on over to the blog and leave your comments.
Until next time,