Low rate home equity loan

Byline: DAVID MYRON

Overdependence on home equity loans and lines of credit have economists concerned that consumers are financially over-extended and ready to cut back on spending.

Too many costs are gnawing away at consumers' wallets, and while the job market has improved over the past year, wages have not kept up with the cost of living.

To combat a significant jump in inflation, in 2000, the Federal Reserve started reducing interest rates, which eventually reached record lows in recent years. Still, the very strategy that economic regulators used to avert economic calamity and encourage consumer spending has encouraged consumers to go more into debt, argues Richard Hastings, an analyst at New York-based Bernard Sands, a retail market advisory firm. "We are now in an inflationary cycle," Hastings warns. "It really is a very serious issue."

He maintains that home equity debt levels are soaring. Additionally, he's concerned that Americans are not only taking advantage of the low interest rates to participate in the ubiquitous American dream of owning a home, but to eliminate high-interest credit card debts. On the surface, transferring high-interest credit card debts to low-interest home equity loans appears beneficial. However, according to Hastings, as home equity loans and lines of credit often enable consumers to borrow up to 10 percent of the value of their home, they are effectively increasing their borrowing power and debt levels.

Supporting his claim, he points to the increasing home equity growth rate in the U.S.. By the first quarter of 2003, home equity loan growth outpaced credit card growth by an average of 5.6 percentage points. By the same quarter in 2004, that figure jumped to 8.4 percent. What's more, U.S. home equity debt was at a record high of $415 billion for the second quarter (ending June 30), a 10 percent jump over the previous quarter, the FDIC reports. If home equity debt keeps increasing at current levels, it's on pace to break $500 billion by the end of the year. This is particularly disturbing to Hastings, as home equity debt was only about $125 billion in March 2000.

"It's out of control. If wages don't grow, and I believe they will not grow enough, and if the overall global economy slows down, and that might happen, this [home equity debt] will be hanging over the household sector to an enormous degree." So enormous, he adds, that much like the stock market bubble burst of the late '90s there could be a home equity bubble burst.

Already, Gen Xers have taken on debt levels that are 78 percent higher than their Boomer parents' debt, almost all of which is due to the high cost of housing, says James Chung, president of Boston-based Reach Advisors, a market research and consulting firm. "Xers didn't buy in before the run up in real estate, and [as of two years ago] their housing debt was 62 percent higher than Boomers at the same life-stage," Chung says. "It's more expensive to be an Xer at this point in life."

And Xers may be paving a similar path for Gen Y. According to the National Association of Realtors (NAR), a significant increase in home-buying is already occurring among Gen Ys. The NAR reports that from 2001 to 2003, the number of buyers under age 25 purchasing their first home jumped 20.2 percent to 345,000 from 287,000.

"Echo Boomers are going into their peak years for buying a first home. That's going to be a big factor going forward," says Walter Molony, spokesman for the NAR. Considering this generation's large size (72 million) nears that of Boomers (76 million), Molony expects the housing inventory balance to be skewed toward sellers. And, in 2005 the NAR forecasts a 4.6 percent rise in U.S. real estate prices.

Hastings expects investments in real estate and the subsequent home equity loans and lines of credit to hurt holiday spending. He estimates that the total retail spending on non-durables and durables will grow by approximately 1.5 percentage points less in 2004 than it did in 2003. He also expects chain store "comparable" store sales during the 2004 holiday season will grow by approximately 2.5 percent to 3.5 percent, compared with the 4.5 percent growth rate in the previous holiday season.