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Home Equity Lines Affecting Credit Card Defaults

[Jul 31, 2009.]


For about the last decade, many Americans were in the habit of using their home's equity to pay off credit card balances.  As long as the home's value was increasing, this cycle of maxing out the credit cards and then using a home equity loan to pay the high interest balances could be repeated again and again.

Nancy Cook published an article July 29, 2009 called "Credit We Don't Deserve" for Newsweek.  In the article she recounts her interview with Charles Geisst who has a new book titled Collateral Damaged: The Marketing Of Consumer Debt To America.  Mr. Geisst says, "From 2000 and onward, people were using their home-equity lines to pay off their credit-card bills to reduce the interest on their credit cards.  Then, they'd congratulate themselves by going out to dinner.  They're not realizing that they're eating part of their house at the same time."

Lenders began reducing the maximum balances on home equity lines shortly after the current housing crisis became obviously serious. {related article} A mortgage in second position such as a home equity loan can rarely make sense of foreclosing.  As values declined sharply in some areas, the home equity lines were no longer in a secure position.  The only way the banks could reduce their risk was to freeze, reduce, or close the HELOCS.   

Fast forward a year and we see that credit card defaults are steadily increasing. "The default rates already are twice what they used to be.  I think it'll get worse," says Geisst.   It seems a logical conclusion that reduced access to home equity lines is causing some of the damage in the credit card business. 

Current statistics estimate that the average household has over 13 credit cards.  That works out to about four credit cards per person.  That could mean there are over a billion credit cards floating around. Geisst says, "The credit-card crisis is still looming."

In the book Collateral Damaged: The Marketing of Consumer Debt to America, Geisst makes several recommendations for new banking regulations.  He recommends that in future, home equity loans be limited to 20 percent of the home's equity based upon an impartial appraisal of the property.  That would mean a home worth $200,000 could only have an equity loan of $40,000 regardless of the balance of the first mortgage.  This would be a radically conservative position as compared with the home equity lines Americans have had.


About Author:

Renee Morgan has been a loan officer for over eighteen years. She is also a freelance writer and guest expert for radio and TV.

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