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Careful: That Credit Line Can Strangle You


In a world obsessed with real estate, few homeowners have paid much attention to the risks of tapping a hugely popular financial product: the home-equity line of credit. They should. Millions of homeowners have taken advantage of rising real estate prices and the tax deductibility of mortgage payments to pay off higher-priced credit-card debt with an equity line of credit. Now, as short-term rates rise, borrowers could be in for some new headaches.

Unlike fixed-rate mortgages, which have dipped in the past year, or even adjustable-rate mortgages (ARMs) that reset once a year, the interest rate on credit lines fluctuates monthly, typically in step with the prime rate. And that has been climbing, from 4% in June, 2004, to 6.25% today.

Lenders say the hike in home-equity rates isn't a big worry for most families. At an average balance of $50,000, a typical borrower's payment has gone from $166 a month to $260 in the past year. That difference, notes Michael McCarthy, general manager of mortgage lender Ditech.com, is not much more than a monthly cable or phone bill.

Still, for those whose incomes aren't rising and who are already stretched, the higher payments hurt. Those with poor credit are already getting hit, with many paying 11% or more, notes Mitchell Ohlbaum, president of Legend Mortgage Corp. in Los Angeles. What's more, the rate caps on home-equity lines are higher than those on ARMs. That means their rates can reach credit-card-like levels of up to 18%. While no one expects rates to reach those lofty heights, they're almost surely headed higher: On July 20, Federal Reserve Chairman Alan Greenspan told Congress the Fed would likely continue raising rates to ward off inflation.

FLAT RATE FEE

Yet even as short-term rates climb, lenders are targeting home-equity loans as a growth area to compensate for a slowdown in refinancing. Home equity borrowings have doubled over the past five years, to $911 billion. To help keep the growth going, Ditech recently introduced a flat rate $49 fee for home-equity loans, similar to its successful $395 flat fee for traditional mortgages. JPMorgan Chase & Co (JPM). gives customers frequent-flier miles based on how much they borrow.

One worrisome area could be "piggyback" loans. These typically are floating-rate home-equity lines taken out by buyers who want to pay less than the traditional 20% down payment but still avoid paying pricey mortgage insurance. Use of piggybacks has soared in recent years, involving about 40% of all amounts loaned for home purchases, estimates real estate research firm SMR Research Corp. That's a concern because borrowers with less than 20% equity in their homes tend to default in larger numbers, both because their payments are higher and because they have less to lose if they hand their keys to the bank.

That hasn't happened yet. But with each new hike in short-term rates, millions more homeowners will be digging deeper into their pockets.

By Christopher Palmeri in Los Angeles


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