Lenders Push Home-Equity Deals In a Move to Attract Borrowers

With rates on these lines of credit at a five-year high, demand is slowing, leading banks to offer new promotions to keep customers borrowing.
By: Ruth Simon: The Wall Street Journal Online
Home-equity borrowing has been a boon to consumers in recent years, essentially allowing them to turn their houses into cash machines. But with rates on home-equity lines of credit at a five-year high, demand is slowing, spurring lenders to keep their business growing with new promotions, rate cuts and other offers.

Wells Fargo & Co. launched a new program last month that cuts the rate on home-equity loans and lines of credit by between 0.375 and 0.5 percentage point for customers who also have a Wells Fargo checking account. Bank of America Corp. is sending out "customer reward" certificates that give borrowers up to half a percentage point off their rate if they take out a home-equity line of credit. PNC Financial Services Group Inc. is offering $25 PNC Bank Visa gift cards - and, in some cases, two free airline tickets - to borrowers who take out a new home-equity loan or line of credit.

As rising short-term interest rates push up the cost of credit lines, many lenders are also pushing fixed-rate home-equity options. Last week, Regions Financial Corp. introduced a fixed-rate home-equity loan with a term of up to 15 years. Before that, the Birmingham, Ala., bank's fixed-rate loans required borrowers to make a balloon payment at the end of five years.

Home-equity borrowing surged in recent years as millions of Americans took advantage of low interest rates and rising home values to pay off high-cost credit-card debt and fund everything from vacations to home improvements. The growth has been fueled in particular by the rising use of home-equity lines of credit, which carry a variable interest rate and give homeowners the right to borrow up to a certain amount, either all at once or as needed over a number of years.

Yet if housing values fall, some home-equity borrowers could wind up owing more than their house is worth. And homeowners with credit lines are vulnerable to rising interest rates, which can make their monthly payments higher.

Already, higher rates are fueling an increased interest in a different type of home-equity borrowing: loans, which offer a lump sum and a fixed rate, instead of credit lines. SunTrust Banks Inc. says that about a quarter of its borrowers are now opting for a fixed-rate home-equity loan, up from 10% a year ago. At Wachovia Corp., 40% of customers are choosing fixed-rate home-equity loans, compared with 30% last year.

Meanwhile, lenders such as J.P. Morgan Chase & Co. and Bank of America are touting newly popular features that let borrowers lock in a fixed rate on some or all of their line of credit. This fixed-rate option "is the largest weapon in our arsenal" when it comes to retaining customers, says Brad Conner, president of Chase Home Equity, which has boosted its home-equity marketing budget by 15% this year.

The cost of tapping your home's equity has climbed dramatically as the Federal Reserve Board has boosted short-term interest rates 15 times over the past two years. Rates on home-equity lines of credit currently average 8.33%, according to HSH Associates in Pompton Plains, N.J., up from as low as 4.64% two years ago, and are at their highest levels since 2001. Rates on home-equity loans have also increased, to 7.96% from 6.75% over the same period.

Yet even at their current levels, home-equity products remain attractive compared to many other kinds of borrowing. Rates on variable-rate credit cards, for instance, currently average 14.14%, according to Bankrate.com in North Palm Beach, Fla.

Home-equity borrowing has become increasingly important to lenders. Balances on home-equity lines of credit have climbed 71% to $543.2 billion over the last two years, according to an analysis by Equifax Inc. and Moody's Economy.com. Home-equity loans and lines of credit accounted for 10% of loans at commercial banks in the fourth quarter of 2005, up from 6.5% in 2001, and are the second-fastest-growing asset class, says Morgan Stanley analyst Betsy Graseck.

Yet growth is slowing. Total home-equity debt outstanding increased 9% in the first quarter compared with the same period a year earlier, according to Equifax and Moody's Economy.com. That's down from the first quarter of 2005, when the year-over-year growth rate was 25%.

"You have consumers that are being reminded every other month that their rate is going up," says John Gellhausen, an executive vice president at National City Corp. Demand for home-equity products could slow further if home-price gains slow and borrowers build up equity at a slower pace.

In a bid to keep business strong, some lenders are introducing customer-rewards programs. U.S. Bancorp this month rolled out its "EquiLine Rate Reward" program, which gives borrowers a lower rate the longer they hold on to their credit line. Under the program, which the bank tested last year, the interest rate on a borrower's credit line drops by one-quarter of a percentage point every six months until it reaches prime minus 1%. National City last month began giving rewards points to customers when they take out a home-equity line or loan and when they access their home-equity line with a credit card. The points can be redeemed for gift cards, consumer electronics and airfare.

In an effort to boost "retention" rates, a growing number of lenders are using computer-modeling tools to identify customers who are likely to pay off their credit lines. Citigroup Inc. offers larger credit lines to eligible borrowers who've almost fully utilized their credit line. Borrowers who've maxed out their credit lines are more likely to pay them off, explains Alan Dakay, president of Citi Home Equity.

SunTrust has boosted its retention staff by 10%; the Atlanta-based lender calls borrowers who are likely to pay off their credit line and sends out "checks" that let borrowers with lines of credit lock in a fixed, promotional interest rate. Forty-seven percent of banks now employ "home-equity customer retention specialists," according to a recent survey by the Consumer Bankers Association, up from 12% in 2005.

Still, rising rates are beginning to pinch some homeowners. More than 13% of borrowers with home-equity lines have balances greater than $95,000, according to Experian Corp.; more than 23% of borrowers owe more than $65,000.

Some borrowers have decided they've had enough. Stephanie McElhaney, a nuclear physicist in Colorado, recently consolidated her adjustable-rate mortgage and her $76,000 line of credit into a new 6.5% fixed-rate mortgage. The line of credit carried a rate of roughly 8.5%, Ms. McElhaney says. "I wanted to lock [a rate in] before it really got outrageous."

Yet this strategy - known as "cash-out refinancing" - doesn't make sense for everyone. Borrowers considering it should look not only at the rate and size of their credit line, but also at their overall mortgage picture. Refinancing may well be a wise move for someone with a large line of credit and an adjustable-rate mortgage that will soon reset. But it's less likely to make sense for a borrower with a low-cost fixed-rate mortgage, particularly if they have a relatively small line of credit, because their overall borrowing cost is likely to rise.

There are other downsides. With a cash-out refinancing, borrowers typically spread the loan payments out over 30 years, says Greg McBride, a senior financial analyst with Bankrate.com. "If you've got a smaller home-equity balance, you can knock it out in 10 years," lowering your total interest costs, he notes. Another factor to consider: Home-equity rates could decrease if slowing economic growth leads the Federal Reserve to begin lowering rates down the road.

Another possibility: Borrowers who took out a home-equity line a few years ago may be able to get a new one with a lower rate. Nearly 10% of lenders now offer lines of credit that are priced below the prime rate, according to HSH Associates, up from 8.9% a year ago. Almost 31% now offer lines priced at the prime rate, versus 28.3% last year.

Another option is to lock in a fixed rate on a portion of your credit line and then unlock it if rates move lower. Some lenders, such as Bank of America, let borrowers lock or unlock their credit line at no cost. At J.P. Morgan Chase, locking in a fixed-rate is free, but borrowers who want to unlock a credit line pay 1% of the loan balance or $250, whichever is smaller.

Homeowners who opt to lock in a rate could still see their monthly payments increase, however. That's because borrowers with home-equity lines often make interest-only payments. Lenders typically require borrowers who lock in a fixed-rate on their credit line to make both principal and interest payments.