May 21, 2007 in Home Equity

Home equity borrowing has steadily gained popularity over the past two decades while relaxed lending standards in recent years have opened up this option to a whole new set of borrowers.

Home equity lending took off dramatically beginning in 1986, says home equity and mortgage lending expert Richard F. DeMong. That’s when the tax code was changed to increase tax incentives for homeowners. Since then, people have been able to borrow 100 percent of their home’s equity and even borrow against future equity with loans for 110 percent or more.

Recently loosened standards, coupled with a softening real estate market, have led to record loan defaults and foreclosures. As the industry scrambles to get its bearings and rethink the logic of some of its subprime lending decisions, consumers should take a moment to do the same.

Borrowing on home equity has become an accepted solution of convenience, with one in every five homeowners currently holding a second mortgage or home equity loan, a 2006 Pew Research Center study shows.

Fierce competition among lenders resulted in easy applications, a fast decision process and an increase in subprime lending (loans granted to people with weaker credit or at higher-than-prime cost). In fact, the subprime market grew from $90 billion in 1996 to $540 billion in 2004, Freddie Mac figures show.

This shift has come at a price to both borrowers and lenders. Lenders have taken a hard hit recently, particularly in the subprime arena with a rash of lenders filing bankruptcy or going out of business. Even large companies have been hit by higher-than-expected default rates.

Lenders are expected to tighten their underwriting standards in wake of this, but it remains to be seen if borrowers will react similarly.

Homeowners have spent the past decade treating their houses like ATMs while expecting them to function as retirement funds. A November 2006 study by the Pew Research Center found that the home comprises “most” of the personal worth for one-third of homeowners (34 percent) and “more than half” for another third (34 percent). And despite changing borrowing habits, these percentages haven’t changed in more than a decade.

If the home is the de facto American retirement fund, when is it reasonable to draw on home equity and when should it be treated as sacred? Find out by reading “The pluses and pitfalls of equity loans.”

Has home equity funded your dreams or turned into a nightmare? Share your story.

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