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Here We Go Again: As Home Prices Rise, So Do Home Equity Lines of Credit

Well, doesn’t this seem like a great idea: home equity lines of credit have staged a big comeback.

After six years of declines, lending for so-called Helocs will rise 30 percent to $79.6 billion in 2012, the highest level since the start of the financial crisis in 2008, according to the economics research unit of Moody’s Corp. Originations next year will jump another 31 percent to $104 billion, it projected.

Lending tied to real estate is reviving as record-low mortgage rates spur the housing recovery while an improving job market makes it easier for people to borrow. A rise in home equity lines is in turn helping the economy, fueling purchase of goods like televisions and refrigerators. Consumer spending, the biggest part of the economy, accelerated to a 2 percent annual rate last quarter from a 1.5 percent pace in the prior period.

Obviously this correlates with the recent rise in home prices, which continued in September, according to the Case-Shiller indices. But this looks to me like another case of playing with a blowtorch. The majority of loans in the bubble period were not subprime originations of new borrowers, but cash-out refinances, where borrowers used their rapidly more valuable homes as ATMs. That’s what we’re seeing here, as people tap the equity in their homes for cash to use on purchases. That may work for the economy in the short term. In the long-term, it’s an incredibly pale substitute for rising wages, and a dangerous one at that.

This is especially true because of the unusual circumstances driving home price appreciation. You have the twin factors of artificially constricted supply and demand boosted by institutional investors scooping up distressed properties for temporary rental use and eventual flipping. If either of those trends reverses, it’s not clear the economy is strong enough to support gradual housing appreciation on its own. And if we see a reversal in the economy, lots of these HELOCs will see defaults, without the escape hatch of rising prices to use for a separate refinancing option.

Home equity is actually rising, despite this, and not all of it is being transferred into cash to use for consumer purchases. But the rise of HELOCs should raise questions about the quality of the underwriting, and the tricks and traps being used by lenders to abuse borrowers. The standard offering for a HELOC is the prime lending rate plus 2 points. But Bank of America is offering double that, adding almost 4 points onto prime. Borrowers should really be wary and shop around for the best deal, and they shouldn’t tap equity unless they absolutely need it. Hopefully everyone hasn’t un-learned the lessons of the bubble.

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David Dayen

David Dayen