Who says home equity loans (second mortgages) are a good idea?
Primarily the banks who pushed home equity loans into the mainstream with a ferocious advertising campaign over the past 20 years. At least that is the case according to a feature article in the New York Times titled Home Equity Frenzy Was a Bank Ad Come True.
Tragically a lot of folks have learned the hard way that treating your house as a piggy bank can be a mistake.
To quote the NYT story…
It might seem hard to believe, but not long ago people borrowed money to buy a home with the expectation that they would eventually pay off the debt. A mortgage had a finish line. You mailed your check to the bank every month for 20 or 30 years, paying interest and principal, and bit by bit, at the end you owned your home free and clear.
The newly mortgage-free even used to throw mortgage-burning parties to celebrate their financial freedom. In 1975, Edith and Archie Bunker torched their mortgage on “All in the Family.” Two years later, the Walton family burned theirs on “The Waltons.” …
[The 1970s and 1980s] was when federal laws allowed mainstream banks to offer second mortgages as well as loans with interest-only, adjustable rates and so-called piggyback features combining first and second mortgages. Until then, such products were primarily marketed to lower-income customers by savings and loans and financing companies, like Beneficial and Household Finance.
Several years ago when the Texas Bootstrap Owner-Builder Loan program was new, we experienced just how predatory some home equity lenders could be. As a reminder, the Bootstrap program offers loans at zero percent interest of up to $30,000 through the State of Texas. The loans are only available to people who agree to build their homes with their own labor under the supervision of a participating nonprofit organization.
At the time, most of the homes being financed under this program were constructed by farm worker in colonias of South Texas. The homes were modest but well built and the program was on its way to becoming a nationally recognized model affordable housing program.
The families who were participating were really poor. I doubt any of them earned more that $18,000 a year. The mortgage payments on their houses were averaging about $125 per month and frankly that was all they could really afford.
Shortly after the first batch of houses were finished several of the new homeowners came to the nonprofit that they had worked with to build the houses to report they were being solicited both on the phone and in person by a home equity lender to take out a second mortgage or refinance their home at from 11 to 14 percent interest in order to pay back medical bills and to get cash out.
Every family who took out one of these home equity loans would have defaulted. The lender knew that they could not afford the loan they were offering. The lender would have repossessed the home and all of the families’ hard work in building their homes would have been lost.
This lender had complied a list of the families who had zero percent loans under the Texas Bootstrap program from the deed documents in courthouse. They sent out a couple of loan officers in a car to call on these extremely low income home owners to try to get them to borrow money to pay off old hospital bills and the like. The home builders under the Bootstrap program were completely unsophisticated when it came to home finance and might have fallen for this had they not checked back with the nonprofit they worked with to build their homes.
Working with Habitat for Humanity, who has also had its low income home builders targeted by high interest home equity lenders, we worked to successfully get the Texas Legislature to pass a bill banning cash out refinances when the borrower has a no interest government loan or similar loan from a nonprofit group like Habitat for Humanity. The refinance and home equity loan prohibition stays in place (with a few exceptions for emergencies) for seven years and then expires.
I related this story to a colleague in the affordable housing business the other day who told me the legislation made him uncomfortable because low income families should be able to “tap the equity in their house just like everyone else.”
This is evidence of just how successful the bank propaganda that is described in the New York Times story has permeated our collective consciousness.
For a family at or near the poverty level to be able to enjoy the security and stability of owning a home, with a government loan, is a major accomplishment. That is the American Dream. Turning their home into a piggy bank to finance other debt is a ticket to disaster to these poor families until they build up sufficient equity and until the federal government acts to prevent lenders from suckering people into loans that the lender knows the borrower cannot afford.
Allowing lenders to strip families’ sweat equity and the taxpayer’s interest subsidies would turn a dream into a nightmare.