Home Is Where The Debt Is

By Gordon Bock

Want "a cash reserve for anything you want, whenever you want it," as New York's Dime Savings Bank promises? Or "a real bargain," courtesy of California First? Those are the kinds of advertising claims that are wafting these days around banking's hottest product, the home-equity loan. A boomlet of sorts is under way as customers respond with enthusiasm to this form of consumer debt, while lenders vie frantically for customers and market share. But amid the rush, cautionary voices are warning about the dangers of the popular loans, and the misleading nature of some of the hype. The major worry: that some unwary consumers may be undercutting an integral factor in most American savings portfolios, the family home.

Home-equity loans are doing a land-office business, expected to double to $70 billion this year (see chart). They are thus gaining rapidly on another method of borrowing against the American home, standard second mortgages, which are likely to be worth $130 billion in 1987. The conventional second mortgage tends to be a short-term, fixed-payment plan for a set amount, based on the value of a home that remains after deducting its first mortgage. But home-equity loans are different: they allow owners to put up their homes as collateral to open variable-rate, revolving-credit accounts good for up to 80% of the equity the homeowner has accrued. Because home-equity loans can be used to buy consumer items, including anything from stereos to luxury cars, their newfound allure comes from a loophole in the Tax Reform Act of 1986, which phased out the deductibility of all interest payments except mortgage payments on principal and second homes. Home-equity borrowing currently offers markedly lower interest rates (about 10%) than an unsecured personal loan (14%) or credit-card loans (about 18%).

But along with those advantages come significant snags that many lenders neglect to advertise. The vast majority of home-equity loans are tied to fluctuations in the prime lending rate, now 8.25%, and can vary enormously in cost as that rate changes. If the prime were to gallop from 8% to 20.5%, as it did between 1978 and 1981, someone now paying 9.75% on a home-equity loan might suddenly have to pay 22.25%. Such a whopping increase is possible because many equity loans lack the so-called caps common to ordinary variable- rate mortgages, which limit interest-rate hikes to two percentage points or so a year.

In their zeal to book new business, some lenders gloss over the fact that failure to pay up can mean the loss of the borrower's home. In a survey of 91 lenders around the country, two consumer groups, the Consumer Federation of America and Consumers Union, found a variety of other alleged abuses. Some lenders failed to disclose that low introductory, or "teaser," interest rates would later be increased. Others did not publicize the fact that their loans required large lump sums as final payments. Last month New York City Consumer Affairs Commissioner Angelo Aponte warned a dozen local banks that their ads "encourage frivolous spending at the risk of foreclosure."

Consumer groups are starting to lobby for tougher legislative restrictions on the loans, including interest-rate caps and more truth in advertising. A spokesman for the American Bankers Association, a lobbying group, responds that "it's not in the banks' interest to fool or abuse their customers." Lenders point out that so far the 30-day delinquency rate on home-equity loans is only .74%, compared with 3.47% for traditional mortgages.

Meantime, some banks are tightening their procedures. Wells Fargo Credit, which operates in eight states, offers five-year, fixed-rate loans at 12.5% interest. Kansas City's Commerce Bank will loan out no more than 70% of a home's appraised value, to avoid saddling customers with too much debt. Officers at Chicago's Continental Illinois are instructed to urge consumers to use the loans for necessities, not just to buy expensive goodies. The best advice to would-be borrowers remains the oldest: read the fine print before signing on the bottom line.

CHART: TEXT NOT AVAILABLE

CREDIT: TIME Chart by Cynthia Davis

CAPTION: ESTIMATED VALUE OF HOME-EQUITY, REVOLVING CREDIT LOANS

DESCRIPTION: Home-equity-loan values, 1982 to 1987.

With reporting by Lee Griggs/Chicago and Raji Samghabadi/New York