Tear Up the Textbooks : Despite Lower Rates, Demand for Home Equity Loans Falls

In defiance of textbook economics, consumer interest in home equity loans is marching in the same downward direction as interest rates.

Since a drop in interest rates makes it cheaper to borrow money, a dip in rates is normally expected to spur loan demand. But with the economy’s outlook still uncertain--and the local employment outlook shaky--consumers are apparently reluctant to take on new debt.

Home equity loans in California plunged 10% during the first six months of 1991, said Charles Campbell, a vice president at Wells Fargo Bank, the nation’s biggest home equity lender. Such a drop makes it likely that home equity lending in the state will be down for the entire year.

“With layoffs and spending cutbacks, people don’t want to take on more debt,” said Wallace Bowen, executive vice president at Fidelity Federal Bank in Glendale.

Consumers aren’t alone in their queasiness about debt. With government regulators preaching caution, lenders are skittish about most types of lending, including home equity loans. Lenders say they’ve tightened their credit standards. For those who want them, home equity loans are harder to get than in the past.

Home equity loans are hybrids that take features from second-mortgages and from credit cards. Lenders give borrowers a line of credit, secured by the equity in their home. Borrowers draw on the credit line as needed, and repay it in monthly installments.

Normally, the interest rate on home equity loans is adjustable. Depending on the lender, the home equity interest rate tracks fluctuations in the prime rate, or in the rates on certificates of deposit or U.S. Treasury bills. For example, with the prime rate now at 8%, the rate on home equity loans pegged to the prime now ranges between 9.5% and 10%.

Once used primarily for home improvement, the popularity of home equity loans surged after a 1986 tax-law change eliminated interest deductions on other forms of consumer debt. Home equity loans have become an all-purpose form of consumer debt, used not only for home improvements, but to finance new cars, college and even vacations.

Last year, home equity lending surged 47% in California to a record $11.4 billion, making it the leading state for home equity loans.

Any drop in interest rates, of course, benefits people who already have home equity loans. Wells Fargo’s home equity rate, for example, has dropped to 9% from 10.89% in January. For people with an outstanding balance of $25,000, minimum monthly payments have slid to $188 from $229.

For many people, though, the reduced minimum payment hasn’t triggered a spending spree. About 80% of the people with home equity loans pay more than the minimum required each month, Wells Fargo’s Campbell said. “These people have a budget for repayment, and they stick to it, regardless of what happens with interest rates,” he said.

Some home equity loans have features that allow the borrower to convert the floating rate loan to a fixed rate loan. This allows borrowers to lock in a low rate, and it makes sense if it appears that interest rates may rise. Financial advisers said that it is less advantageous to convert to a fixed-rate loan nowadays, when interest rates are falling.

Lenders are fond of home equity loans, because the default rate, though higher this year, is still relatively low--less than 1%. The American Bankers Assn. reported that the delinquency rate for home equity lines edged down from 0.98% in the first quarter to 0.90% in the April-to-June period. Still, it was substantially higher than the 0.75% rate a year earlier.

Lenders in Southern California are actively competing for home equity loans, trying to entice borrowers with offers to waive fees. Normally, lenders charge borrowers for closing costs, appraisals and other fees that can come to $400 or more.

At the same time, however, lenders are increasingly picky about who gets a loan. First Fidelity, for example, tightened its debt-to-income ratio, one measure of credit-worthiness.

Many institutions are stingier about how much they will lend, due to uncertainty about real estate values in certain areas. Last year, one-third of all banks reported that the value of homes belonging to home-equity borrowers fell by 10%, according to the Consumer Banking Assn. Lenders are now requiring a larger equity cushion on the amounts they will loan.

For people with expensive homes--those with a value of $1 million or more--the home equity market is tougher.

Tapping Home Equity

Four of the top five banks in the United States for home equity lending are in California. The following is a look at the top five lenders as of March 31.

Home equity loans Rank Bank (in millions) 1. Wells Fargo Bank $2,934 2. Bank of America $2,893 3. Security Pacific $1,941 4. Citibank (New York) $1,567 5. First Interstate $0.965

Source: American Banker.