The popularity of the HELOC in the United States can be traced back to the beginning of the present decade. Borrowers started to appreciate the fact that HELOCs allowed them to set a borrowing and repayment timetable in accordance with their specific needs.The fact that HELOC interest payments were deductible under Federal and state tax laws added to the attractiveness of this loan option as an economical way of refinancing debts and paying for those intermittent heavy expenses that challenge family finances — home improvements, university tuition, weddings etc.
The Prime Rate Gamble
The HELOC is almost invariably linked to the prime rate, with an additional margin added to cover the amount the bank needs to earn to cover the risk on the loan and the profit they hope to gain. Where prime rates are low, the borrower is at an advantage to other borrowers who take out fixed loans, but the situation can rapidly be reversed should prime rates rise. For example, during 2003 the prime rate was stable with just a single change to a low of 4% in June. However, over the period 2004 to 2007 it changed 17 times and reached a peak of 8.25% in June 2006. A significant decline in prime rates in the first half of 2009 saw this rate falling to 3.25% – the last time it was so low was in 1955!
Financial Crisis and the HELOC
The current financial crisis has had a serious impact on the HELOC market: Housing values have fallen and rising unemployment has impacted on the abilities of many borrowers to meet their loan repayments. In the first quarter of 2009 almost 2% of all HELOC accounts had become delinquent. If the borrower fails to meet their obligations the bank stands to gain possession of their property, but if it cannot easily be sold it may not be worthwhile for the bank to acquire it. Already in 2008 the fall in property values led leading HELOC lenders (such as Bank of American, National City Mortgage and Wells Fargo) to restrict or even freeze borrowers’ lines of credit. New HELOCs issued by JP Morgan Chase fell by an amazing 89% as house prices plunged by 50% in some areas.
While banks have become concerned about the security of their loans, the economic downturn has enhanced the appeal of the HELOC to borrowers. Faced with rising debt burdens borrowers are more tempted than ever to consolidate their debt payments by taking out a HELOC. In this way they can benefit from lower interest rates than the credit card companies charge and they also qualify for tax concessions. Yet if HELOCs are becoming more attractive from one perspective, from another perspective their appeal may be diminished by news of the number of borrowers losing their homes through defaulting on their loan obligations.
Crystal Ball Gazing
To determine the wisdom or otherwise of financing or re-financing with a HELOC you would have to have a good idea of future trends in the prime rate. Some analysts believe that the prime rate has reached its low point and it is unlikely to fall further, but the mute question is how far it is likely to rise? Even if you are confident that prime rates are not going to rise markedly, until the property market recovers new HELOCs are likely to be in short supply so many prospective borrowers may not be given the choice between taking a HELOC and other financing options.