FEBRUARY 2005

Red Hot Home Equity Market
Foreshadows the Future

Readers of this newsletter in recent months know that consumer lenders, especially credit card issuers, are responding to an apparent sea-change in the way that consumers borrow. Home equity lending is offering lenders the best growth opportunities for the mass market over the next decade. Credit card issuers, especially the monoline issuers such as MBNA and Capital One, have taken note and are adjusting their business models accordingly. In the monolines' case, the shift begins with the establishment of recognizable brand names. Cap One has been working on this for several years through its memorable "What's in Your Wallet?" ad campaign, and MBNA began doing the same with this year's Super Bowl spots. The effort positions both companies to evolve from anonymous credit card issuers in order to cross-sell other, more profitable products such as home equity lines of credit.

The following statistics indicate why such moves are critical. According to the market research firm SMR Research Corp, (Hackettstown, NJ), home equity originations rose 35 percent in 2004 to reach $431 billion. Countrywide Financial's home equity originations were up 71 percent. Wells Fargo's home equity originations rose 45 percent. Another consulting company, Benchmark Consulting International (Atlanta, GA) said the average size of a new home equity line rose to $78,000 in 2004, up from $57,000 in 2001. The Federal Deposit Insurance Corporation says that home equity loans are the fastest growing asset class on the balance sheets of financial institutions. Statistics from the Federal Reserve Board indicate that home equity loans and lines of credit accounted for about 25% of the growth in mortgage debt during the third quarter of 2004. Of course, much of this growth has been at the expense of credit card issuers, as consumers have transferred higher cost credit card balances onto home equity lines.

Utilization rates on home equity lines are rising as well. Loan Performance, a mortgage industry benchmarking and consulting firm (San Francisco, CA) says that borrowers had tapped about 51% of their lines as of October 2004, up from 46% a year earlier. Average interest rates on home equity lines are substantially below rates on the 12.2% average rate on credit cards, according to Bankrate.com. Plus, interest on the first $100,000 of a home equity lines is tax deductible. Most home equity line interest rates are tied to the prime rate, with some lines offered at below-prime rates.

Given that so much of home equity debt is adjustable-rate debt, what happens to borrowers as interest rates continue to rise? SMR Research offers the following illustration. A home equity borrower with a $50,000 balance on a 15-year line of credit would pay about $370 per month at a 4% rate. If rates rise to 5.25%, the monthly payment rises to $402. At a 7% rates, the monthly payment rises to $449. These are relatively small increases for most home equity borrowers, and the interest will typically remain tax deductible.