Many Homeowners Who Depleted Their Equity Sink Deeper Into Debt
By Paul Wenske
The Kansas City Star
January 18, 2005
Like millions of Americans, Jerry Whetstone joined the rush to tap the equity in his home a few years ago.
Whetstone and his wife figured that with his sales job and her nursing degree, they were financially solid. So to pay off student loans and credit cards and to finance other needs, they took out a $ 70,000 equity loan on the Kansas City house they owned outright.
[Sad to say it was the stupidest decision in his life. I feel very badly for this guy. mish]
Then Whetstone's wife got cancer and he was laid off from his job. By the time Whetstone's wife died in July, their credit card and other debts had ballooned. The interest on the home equity loan also grew, from 4.25 percent to 6 percent.
Now Whetstone faces selling his house to pay his debts. With extensive improvements, the house might fetch $ 150,000, but he doesn't have the money for that. Whetstone thinks at best he can get about $ 100,000.
"We thought if we could maintain our jobs, no sweat," he said. "There's denial when you are looking at 4.2 percent. It's better than this credit card. Still, you have to pay the loan back."
The housing and refinancing boom, sparked by historically low mortgage rates, prompted millions of Americans to see their homes as possible piggy banks. While many borrowers used refinancing to greatly improve their household cash flows or consolidate higher-rate consumer and credit card debt, some used it to take on debts they now can't afford.
Thanks to rapidly appreciating home values, the Federal Deposit Insurance Corp. estimates that the total equity held by homeowners has increased $ 2.2 trillion since 2000. In the Kansas City area, the average home price increased 31.6 percent over the five-year period ending Sept. 30, according to the Office of Federal Housing Enterprise Oversight.
But there is growing concern about the dark side of the refinancing, home equity loan and line-of-credit boom.
According to the Joint Center for Housing Studies at Harvard University, between 2001 and 2003, Americans turned about $ 333 billion in home equity into cash. Between 2001 and early 2002, Federal Reserve statistics show, 44 percent of Americans who refinanced with fixed-rate mortgages pulled cash out of their homes. Of those who refinanced with adjustable-rate mortgages, 57 percent pulled cash out.
Many homeowners who depleted their equity continue to borrow to purchase new cars, build new decks or just make ends meet. Now they are sinking deeper into debt. As interest rates rise, some financially strapped homeowners risk losing their most valuable assets -- their homes.
New government and consumer studies warn that if housing values stagnate or tumble -- a concern focused more on red-hot coastal markets than in Kansas City -- millions of homeowners could be devastated. The studies also predict repercussions for the economy, which has been carried largely by consumers who, in a period of stagnant wage and job growth, spent liberally using money they carved out of their home equity.
"If home values bust, many of these homeowners will be devastated," said Javier Silva, author of a new report, "A House of Cards: Refinancing the American Dream," released this month by Demos, a New York-based nonpartisan public policy organization.
Demos found that while a record number of Americans own homes, on average they own a smaller share of their homes than Americans did in the 1970s and '80s. Home equity actually has fallen, from 68.3 percent in 1973 to 55 percent through the second quarter of 2004.
The report echoed concerns of financial experts that the refinancing boom blurred the line between unsecured debt, such as credit card debt, and secured debt backed by a solid asset such as a home, which long has been a personal source of wealth and security.
"It's like buying a Big Mac with a credit card and then transferring that debt to your mortgage -- now you are mortgaging your home for a hamburger," said Kevin Glendening, deputy commissioner in the Kansas bank commissioner's office.
Federal statistics show an increase in delinquent payments on home equity loans, suggesting growing problems for some consumers.
Delinquent payments can result in late fees, lower credit scores that make it hard to get good loans, and foreclosures. Ultimately, when the debts become more than consumers can manage, experts look for a surge in bankruptcies.
"While nobody has a crystal ball, increased consumer debt ratios may be a sign that more families are in financial distress," said Ted Janger, a professor at Brooklyn Law School and a former resident scholar at the American Bankruptcy Institute.
Similar warnings are sounded in the FDIC's winter outlook. Although the total equity held by homeowners has risen sharply, the FDIC notes that mortgage debt rose to a record 72 percent of household debt in 2003.
The report expresses concern that homeowners, squeezed between higher interest rates and stagnating or falling home prices, could face problems servicing their debts, causing them to become delinquent or unable to repay loans.
"Home prices cannot rise faster than the fundamentals," Richard Brown, the FDIC's chief economist, said in a phone interview. "Those appreciations can't be sustained long term. Households that have taken on more of these risks and more debt are more vulnerable."
Many Americans took on the risks because of low interest rates. Banks and mortgage brokers encouraged Americans to refinance their home loans. When the refinancing boom slowed in 2003, lenders began to aggressively market equity lines of credit to generate new loans, the FDIC said.
One frequently cited argument used for converting consumer debt and credit card debt to mortgage debt is that the interest paid on mortgage debt is tax deductible.
But the equity credit lines, unlike most mortgages, carried adjustable interest rates. While they started as low as 4.2 percent, they began to climb last year when the Federal Reserve began raising the prime rate.
The FDIC report also expressed concerns that some banks, tempted by hefty profits, are loosening their underwriting practices and making riskier loans. Investigators in some states have looked into allegations that some overzealous brokers pressured appraisers to inflate appraisals to induce more loans.
The FDIC report concludes that now, with many Americans deeper in debt, more consumers are "in a weaker position to repay the loans."
Elizabeth Watkins, a senior loan officer at Advance Mortgage in Overland Park, said some people are returning to refinance their loans and consolidate their debts once more, even though interest rates are higher. Just to keep their payments low, some borrowers have taken out loans with adjustable rates that start low but risk going higher in three years.
"People paid off their debt, and now they have debt again," Watkins said. "Now they're very embarrassed. You have people laid off, people with life-threatening emergencies and people with kids in school."
Home values in Kansas City still are going up, though less rapidly than in recent years, so people still have equity to work with.
"The real problem will come if home values depreciate," Watkins said.
Watkins tries to move clients as soon as possible into fixed-rate loans, even if the rates are higher yet. The process has left her much more wary of how easy it is to lose one's nest egg.
"You have wealth sitting in your house, but you have to respect it for what it is," she said. "Use it if you need to, but do it with your eyes open."
Necia Gamby thinks she is doing just that. Gamby lives in a house near midtown that she and her mother bought about 10 years ago for $ 64,005. But its value soared to about $ 200,000, as people have begun moving to the area.
Over the past three years, Gamby has refinanced her home three times, using the money to repair her credit, consolidate medical and education expenses, and pay for a new roof, windows and siding, which have improved the value of her home.
Gamby now has a fixed 30-year mortgage at 6.5 percent, but she also owes $ 143,000 on her mortgage.
Still, Gamby said, she has no more high-interest revolving debt.
"What I pay for, I pay for in cash," she said. "The biggest debt I have is the house."
And because Gamby, a massage practitioner, moved her business into her home, she enjoys an added tax deduction.
Gamby said she doesn't take her home for granted and studies ways to improve her financial health and future.
"People don't understand what they are getting into," she said. "My house is not a throwaway thing to me. It is the cornerstone of my life. I never want to put it in jeopardy."
In contrast, the Demos report concluded that many Americans see their homes and lives in jeopardy because of the gnawing-away of their once-treasured equity.
The report seeks more congressional attention to the issue, stating that as home equity declines and debt burdens rise, "we are putting our financial future at risk."
SEEKING SOLUTIONS: Refinancing a home loan to get a lower interest rate, take advantage of your home's appreciation and consolidate debt can be a wise move. But there are pitfalls that can lead to even greater debt. Here are some tips on how to avoid the pitfalls:
--The refinancing boom is nearly over, but if you check the market you may find a better interest rate on your mortgage.
--Look for a fixed-rate loan that locks in a low interest rate, as opposed to an adjustable loan that is subject to rate increases.
--An equity line of credit is a low-cost option to higher-interest credit cards and can be tapped when needed. Unlike most home loans, an equity line of credit is adjustable and subject to rate increases.
--Home loans and equity lines of credit offer other advantages to credit cards, such as tax deductions. But they are secured by your house, and if you don't pay them back, you place your house at risk.
--If you refinance your house or take out a line of credit to consolidate debt, avoid getting trapped into new debt on credit cards, many of which have lately increased rates and shortened grace periods.
--Work with a competent mortgage broker who has your best interests at heart and won't put the equity of your home at risk.
--Avoid loans that offer you 125 percent of the equity in your home. A missed payment could lead to foreclosure.
--Be certain your house is appraised properly. If the appraisal is inflated, the value of your home may not be enough to support your loan, and you could owe more than the value of your home.
--Paul Wenske
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