Homeowners Continue To Drain Equity

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Sixty percent of domestic banks reported that between 10 percent and 30 percent of their customers increased their outstanding balance when they refinanced their mortgages, and more than 25 percent of banks reported that more than 30 percent of their customers had done so, according to the Federal Reserve Board's Senior Loan Officer Opinion Survey on Bank Lending Practices, January 2002.

The survey said credit standards for approving residential mortgages were largely unchanged over the past few months, continuing the "easy-money" policy to borrowing consumers have enjoyed since the early 1990s and continue to do so even with a tighter economy.

Loose underwriting may have already begun to take a toll on first mortgages in the subprime category, according to the Federal Deposit Insurance Corporation.

The FDIC said loans originating in 2000 have higher delinquency rates than similarly aged loans made in prior years and blamed the recession, but the higher delinquency rate could also reflect looser underwriting standards used in 2000 compared to prior years. The easy-qualifier, subprime loans are not recession tested. "These lending programs are now being tested by recession, in most cases for the first time. Even before the recession began, there was already evidence that some subprime credit card borrowers had begun to show signs of rising stress," the FDIC said in a statement released last week. Exacerbating recessionary pressures and loose underwriting are higher loan balances among home owners who are withdrawing equity to pay down debt. Domestic banks told the Federal Reserve customers who increased the outstanding balance of their mortgages during refinancing typically did so by 5 percent to 15 percent, but some banks reported customers commonly increased the size of their loan by as much as 25 percent.

One-fourth of the respondents indicated that more than one-half of their customers who received cash out from their refinancing used the funds to repay other debt, and an additional one-third reported that between 30 percent and 50 percent of customers used the funds from refinancing for this purpose.

The majority of banks also reported that only 30 percent of these customers used the funds for home improvements and related consumer expenditures.

Paying down debt, especially debt with no tax benefits, can help ease a home owner's monthly bill burden, but it does place the home in greater jeopardy. Unless you are disciplined enough to rip up credit cards and close accounts, the practice could create a financially destructive cycle that could cost you your home.

Experts say an equity loan or refinance with cash out is an equity depleting loan and that the best use of borrowed equity is always capital improvements -- home improvements, education and new business financing -- loans that generate a return on your money.

Previous studies by both Freddie Mac and MGIC Capital Markets Group revealed the increased incidence of equity tapping habits not necessarily in the best financial interest of home owners.

Some fiscally conservative financial counselors advise holding onto your equity except for emergencies in tough times -- as some Americans are now experiencing.

Loan officers from 55 large domestic banks and 23 U.S. branches and agencies of foreign banks participated in the FRB survey. The survey focused on changes in the supply and demand for bank loans over the past three months, including the behavior of customers who refinanced their residential mortgages over the past six months and the credit quality of loans to households.