A combination of economic factors is inflating home equity line of credit balances just as a controversial Freddie Mac pilot program for purchase of closed-end home equity loans readies to launch.
Both coincide with the rise of tappable home equity to a new record level — $17.6 trillion — with nine out of ten Americans having some equity they can borrow against.
The level of home equity borrowing hasn’t reached anywhere near the level that was seen around the time of the Great Financial Crisis. However, that specter was invoked back in May when trade associations and others objected to the then-proposed, and since approved, pilot plan for Freddie Mac to purchase closed-end home equity loans made on properties where the secondary market agency already holds the primary mortgage.
In opposing the Freddie Mac proposal, the American Bankers Association noted that home equity lending does not expand homeownership, instead benefiting people who already own, and therefore was not the agency’s mission.
“As demonstrated during the financial crisis of 2007-2008, encouraging access to that equity can be bad public policy and can threaten market stability,” ABA wrote in a comment letter. “Despite the dramatic increase in home values in recent years, home values do not always increase, and can decrease, sometimes rapidly.”
Closer to the ground, Debrah Kim, a community advocate and housing counselor based in the Los Angeles area, also opposes Freddie Mac’s move. She called the program mostly of use to more affluent borrowers.
But on another note, Kim worried about outcomes for other borrowers. “As a housing counselor, I’ve seen firsthand the damage done when homeowners struggling with existing mortgage debt get lured into riskier products like these that put their long-term equity at risk. This sets up the next crisis down the line.”
Here’s a rundown on the multiple storylines of the home equity credit sector.
Rising Equity and Rising Need Perk Up Use of a Slowed Credit Type
Tappable equity is defined as the level of equity a homeowner can use to secure home equity credit while maintaining a 20% cushion. The $11.5 trillion figure (as of the end of June) was reported in the August Mortgage Monitor report from Intercontinental Exchange (ICE), formerly known as Black Knight. The company found that tappable equity rose 4% over the first quarter and 9.2% over the second quarter of 2023.
ICE says that 32 million households have $100,000 or more in tappable equity currently, and 4.6 million have $500,000 or more to draw on. Beyond that, 1.2 million have potential access to $1 million or more.
Homeowners with credit scores of over 760 hold two thirds of the tappable equity and two thirds of those with tappable equity have primary mortgage rates below 4%. This makes using home equity financing more appealing than refinancing the entire home at today’s higher interest rates.
Indeed, this scenario is what has pushed home equity credit, especially HELOCs, back onto prospective borrowers’ radar, according to the New York Federal Reserve District Bank. The N.Y. Fed says that nearly 70% of outstanding mortgages carry rates around three percentage points lower than prevailing rates.
“After nearly 13 years of decline, balances on home equity lines of credit have begun to rebound, gaining 20% since bottoming out at the end of 2021,” says a blog on the N.Y. Fed’s website, based on research compiled for its Quarterly Report on Household Debt and Credit, compiled in cooperation with Equifax.
The report, published Aug. 6, states that current underwriting on lines of credit is tighter than during the early 2000s. Nevertheless, outstanding HELOC balances increased by $4 billion, which is the ninth consecutive quarterly increase in balances since the first quarter of 2021. Total balances stood at $380 billion at the end of June. (Closed-end home equity loans are counted in overall mortgage balances. N.Y. Fed researchers said during a press briefing that they could not break out the home equity loan component.)
Citizens Bank, a leading home equity line and loan lender, had the second-highest level of activity in the first quarter at $1.74 billion in originations of closed-end second liens and new commitments for HELOCs, behind Bank of America with $1.94 billion, according to Inside Mortgage Finance.
During the company’s second quarter earnings briefing Bruce Van Saun, chairman and CEO, told analysts that the bank’s HELOC originations remained “incredibly strong, and with rates being higher than we had expected going into the year and our customers having the most home equity in their personal balance sheet in the history of the U.S., our HELOC market position is reaping a lot of benefits for us.”
N.Y. Fed researchers said during the press meeting that they consider today’s HELOC borrowers to be comparatively lower risk, although home equity loan borrowers’ credit is usually not as strong as line of credit borrowers. Despite many people being super prime borrowers, staff said that only about half of the HELOC borrowers had super prime status.
Read more: Should Banks Beware Credit Score ‘Grade Inflation’?
How Much More Can HELOC Balances Grow?
How long this can go on hinges on interest rates — recent stock market trends and more have encouraged speculation the Federal Reserve Board could cut rates sooner than later — as well as on the housing supply. ICE notes that its Home Price Index indicates that the rate of home price growth has been slowing, through June.
“Will the upswing in HELOC borrowing continue? The answer is not so clear to us,” N.Y. Fed analysts wrote in the Liberty Street Economics blog.
Much hinges on the difference between mortgage rates and home equity rates. If mortgage rates fall sufficiently, cash-out refinancings could become attractive again, but HELOC rates — which are frequently floating — would move with market rates. Generally, HELOC rates, as a secured loan, carry lower rates than do unsecured credit cards.
The staff notes that “existing homeowners are disincentivized to cash-out refinance if they are locked into a mortgage at a rate lower than the prevailing rate, since that would leave them with a higher mortgage interest rate. Additionally, if home prices remain high and the amortization of first mortgages increases available home equity, there could be higher demand for HELOCs.”
That said, they also suggest that the rise in HELOC balances “might prove to be a short-term deviation.” On Aug. 8, in its Quarterly Credit Industry Insights Report, TransUnion noted that originations are falling.
“Home equity originations were down 4% year over year to 472,000 in Q1 2024,” TransUnion says. “HELOC originations fell 7% year over year to 234,000 in Q1 2024, which marked the fifth consecutive quarter of year over year declines. Home equity loan originations fell 1% year over year to 237,000 in Q1 2024.”
Read more: Even as Financial Worries Grow, U.S. Consumers Keep Using Credit Cards
Freddie Mac Purchase Pilot: Borrower Boon or Biden Boondoggle?
Back in April Freddie Mac asked the Federal Housing Finance Agency (FHFA) to approve a pilot program that would enable the government-sponsored enterprise to purchase qualifying closed-end home equity loans originated for mortgage borrowers whose primary mortgages had already been sold to Freddie Mac. (The FHFA oversees both the Freddie Mac and Fannie Mae organizations, both in federal conservatorship since the financial crisis.)
Freddie Mac proposed the pilot as an effort to provide a secondary market for second-lien loans for borrowers, enabling them to access equity without having to refinance their entire home at today’s rates. As approved by FHFA in the face of much opposition, the purchase volume is capped at $2.5 billion and the pilot, which had not launched as of early August but was expected to soon, would run for 18 months. Individual loans cannot exceed $78,000.
When it was first filed, Freddie Mac’s proposal immediately became a political lightning rod.
A group of leading Republican senators and members of Congress attacked the idea in a May letter. The group wrote that if implemented the program would “exacerbate inflation, disrupt the home equity lending and consumer credit markets, and increase risks to taxpayers.” They suggested in the letter that Freddie would compete unfairly with private sector lenders and would become a consumer lender, given that home-equity credit is not used for home purchases.
Subsequent to the letter members of the group claimed in press comments that the effort was a Biden administration effort to stimulate the economy and favor better-heeled citizens through an agency meant to increase homeownership opportunities. Tim Scott, Republican senator from South Carolina and ranking member of the Senate Banking Committee, called it “a political stunt.”
For their part, industry commenters pointed out that a healthy market for home equity loans already exists and that a secondary market for home equity securitizations has been growing.
“This product is commonly offered to their customers by community banks and other financial institutions throughout the nation,” wrote the Independent Community Bankers of America.
The Mercatus Center, a libertarian think tank, wrote that “there appears to be no market shortage of credit available to procure consumer and second-mortgage loans for non-mortgage-related spending,” citing loan figures from FDIC’s own database. The letter was signed by Thomas Hoenig, distinguished senior fellow — and also a past FDIC vice chairman and president of the Kansas City Federal Reserve Bank.
“There is no lack of capital, or competition, in this market,” wrote the Housing Policy Council, which represents mortgage originators, services and other elements of the private sector home lending industry.
However, other organizations supported the move. The Center for Responsible Lending said home equity loans were difficult to impossible to obtain for many people who are minorities or veterans or who have low wealth or low credit scores. The group indicated that many are forced to cash-out refis to tap their equity, which winds up costing them more.
Indeed, in issuing the conditional approval, Sandra Thomson, director of FHFA, said that enabling people in areas where they cannot obtain home equity financing from the private sector now would help fulfill Freddie’s home ownership purpose. Currently, she wrote, if they can’t obtain second-lien financing they “are forced to sell their home when a financial need arises.”