Banks have changed the way they lend even to those in good standing
For decades, Americans have used home equity withdrawal at minimal rates—That was until the 1990s. During the housing boom, loans against homeowners’ equity exploded.
Home, or mortgage equity, withdrawal is the amount of equity borrowers withdraw from their homes; in the form of home equity loans, lines of credit, and cash-out refinances. This is often used as a predictor of consumption spending since a portion of the fund is spent for immediate needs.
Economists cite two effects of the Home Equity Withdrawal (HEW)… The first implies a negative relationship between HEW and saving rates. If the property market slows down, HEW follows; and therefore, consumption is adversely affected too. The second cites that some factors, like rising income expectations and positive housing outlook, influence the total HEW to increase. Immediate consumption only rises slightly, unlike in the first relationship mentioned. The savings rate increases because of households’ reaction to lower wealth rather than lower HEW.
A complementing study entitled “Is Housing Wealth an “ATM”? The Relationship Between Household Wealth, Home Equity Withdrawal, and Saving Rates” by the International Monetary Fund’s Vladimir Klyuev and Paul Mills, found that “… U.S. households react to an increase in their net worth and lower real interest rates by reducing their saving rate. HEW also has a negative impact on household saving in the short run, although its size is limited. This result indicates that the likely slowdown in U.S. house price growth, HEW, and tightening financial conditions will lead to a recovery in the U.S. saving rate… That said, a decline in the growth of HELs and cash-out refinancing may have at least as large an impact, and possibly a more persistent one, on housing investment through its effect on home improvement spending.”
But today’s financial crisis has added another external factor to this relationship. The country’s large banks have temporarily suspended HEW from home equity lines of credit (HELOC) last year for fear borrowers might not be able to repay loans once the amount they borrow exceeds the actual value of their home. Home values have fallen even lower than the period where they started suspending; and with foreclosures increasing, there’s a higher probability borrowers will default.
But the move highly affected even those paying their dues on time. Most banks, including Countrywide, halted their loans even to clients in good standing. In August, Morgan Stanley followed suit. This brings us back to the relationship above…
Because borrowing has been constrained lately, consumption won’t be that easy to fuel the economy this time. That means more hardships for the typical American who needs to finance college tuitions, medical bills, and other necessary expenses through the HEW.