In the aftermath of the financial crisis of 2007 and 2008, loan volumes declined precipitously. By the end of 2010, aggregate U.S. consumer credit card balances had retrenched nearly 20% from pre-recession levels. Over the same timeframe, auto loan balances declined by 11%, mortgage loan balances by 7%, and home equity line and loan balances by 18%.
By 2011, auto loan balances had started to recover, and credit cards followed shortly thereafter. Mortgage loan balances lagged a bit further behind, continuing their downward trend through 2014, but have since shown significant gains. The auto loan market turned especially robust in recent years, and aggregate auto balances are now 40% above their 2008 levels.
With consumer credit card balances and mortgage balances now sitting at or around their pre-recession levels, you have to wonder: What happened to home equity loans? Home equity loans and lines have continued to steadily erode — quarter after quarter, year after year — and now total balances sit 50% below their January 2008 levels.
Where have all the home equity loans gone? Why have consumers returned to other credit products but not home equity borrowing? And will the decline ever reach a nadir, or will balances inexorably fall toward zero?
Certainly a logical explanation in the decline in home equity lending would be a decline in home equity itself. And in fact, the aggregate owners’ equity in U.S. homes as a proportion of total home value has declined — from 45% in January 2008 to 38% in 2011 — leaving less capacity for consumers to borrow against. But that alone isn’t a sufficient explanation. The combination of reviving home values and diminished equity balances has inflated owners’ equity with the equity-to-value ratio returning to the pre-recession levels in 2013 (45%) and soaring to 58% in early 2017.
Key Question: If consumers see abundant equity in their homes, why are they eschewing home equity loans and lines?
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1. Once Bitten, Twice Shy
During the trough of the recession, many over-leveraged home owners approached foreclosure, with some less fortunate borrowers suffering that fate. Now, even as the economy has recovered, and home values along with it, those same consumers remain reticent to risk their homes by assuming the leverage levels they once carried — and that brought severely stressful consequences.
2. Lender Apathy
Even if consumers may want equity loans, banks and credit unions don’t seem particularly enthusiastic about offering them. In the peak borrowing years before the recession, favorable pricing offers for equity lines were abundant. Direct mail campaigns ran rampant, and marketing touted no-closing-costs, six-months zero-interest teaser rates, prime-minus pricing, and similar radical enticements. But in recent years, such offers have essentially vanished, with even the most favorably priced loans now on prime-plus terms.
Banks and credit unions could reignite demand not only through pricing, but also through internal sales incentives. And by reinforcing pricing premiums through sales incentives, lenders can drive more aggressive prospecting of potential clients for any product. Conversely, the diminishment of sales incentives that may accompany the desire to recalibrate balance sheets can have a multiplicative impact on the decline in product sales. If banks are strategically opting to generate asset growth through different sources (e.g., fixed mortgages, commercial loans), they can’t overtly reject customer requests without risking long-term brand damage. But they can dissuade employee prospecting through incentive changes and customer enthusiasm through pricing changes.
3. How The Math Pencils Out
Third, pricing notwithstanding, consumers may see less need for home equity borrowing in the current low-interest rate environment. One of the primary benefits of equity borrowing is the tax-deductibility of the interest; and when rates are higher, that benefit creates greater financial impact. At a time when the prime rate is hovering near 4%, the tax benefit may not carry sufficient value to prompt consideration of equity products, with all their closing costs and risks to the primary residence, versus non-real-estate-secured instruments.
4. New Car vs. New Kitchen
The low-interest environment, while minimizing the benefit of tax deductibility for equity loans, has also allowed tremendously attractive, near zero-rate auto loans. In many cases, the cost of financing an auto through a dealer-provided nondeductible loan remains less than even the after-tax cost of doing so through a home equity loan. In that auto purchases rank among the more frequent uses of equity lines, the favorable auto loan environment has usurped demand for equity loans.
What Does The Future Hold?
Any or all of the factors listed above could change quickly, fueling a resurgence in equity borrowing. Consumer memories fade, and people will eventually discount the likelihood they’ll get burned again, so any continued strength in home values should spur consumers to return to home equity borrowing. Interest rates have increased over the past year and are forecast to continue increasing throughout 2018, which will increase the benefit of residence-secured borrowing. And after numerous consecutive years of sales gains, 2017 auto sales are projected to reverse, and with less volume, auto dealers may be less willing to compromise per-unit profits with bottom-rate financing. If each of those events occur, consumer demand for equity borrowing will return with a vengeance. If/when that happens, banks and credit unions will need to be prepared to respond aggressively.