Home equity is back, so why aren't more people borrowing?

By Christopher S. Rugaber
AP Economics Writer

WASHINGTON (AP) — Alicia Johnson and her husband wanted to renovate their home last fall but ran into a roadblock: When they tried to refinance their mortgage and borrow against their equity, five banks said no.

Problem was, the Johnsons’ mortgage covered their home in Christiansburg, Virginia, and some adjacent land — a deal-breaker.

“They all pointed to the same thing: The rules have changed,” she said. The banks refused to lend against both the home and the land.

Their frustration reflects a major factor slowing a still-sluggish U.S. economy: The inability of many to tap their home equity.

Americans have long borrowed against the ownership stakes in their homes to buy cars, build decks and renovate houses. That borrowing helped accelerate consumer spending, the U.S. economy’s primary fuel — until the housing bust struck a decade ago and shrank home prices.

But prices have recovered, and housing equity now equals 58 percent of home values — the highest point since 2006. Yet borrowing against that equity has barely budged from post-recession lows, which helps explain why consumer spending remains weak eight years after the Great Recession ended.

The main problem, according to consumer surveys and banking analysts, is that despite low interest rates, it’s become harder to borrow. The web of lending regulations that was tightened after the financial crisis has yet to be eased. Many households would like to borrow more through home equity credit lines or cash-outs from loan refinancings. But having been burned by defaults during the financial crisis, banks are demanding nearly pristine credit.

“It’s harder to do a cash-out refinancing or get a home equity line of credit than it used to be,” said Karen Dynan, who was a chief economist at the Treasury Department in the Obama administration. “That has dampened the housing wealth effect” — the tendency of households to spend more when home values rise.

Johnson, 54, had hoped to spend $30,000 on the renovation. It would have meant building a music studio and adding wheelchair ramps and other modifications for her husband, a disabled veteran. That project is now on hold.

Americans do carry slightly more overall debt than before the recession, according to data from the Federal Reserve Bank of New York. But that’s mainly because of huge increases in student loans. By contrast, the kind of debt that fuels consumption — credit card borrowing as well as housing debt — remains well-below pre-recession peaks.

Research from the New York Fed suggests that if home-equity-related borrowing were to regain healthier levels — dating to the early 2000s, before the housing bubble — the economy could accelerate by three-quarters of a percentage point a year.

Stricter lending rules aren’t the only factor restraining borrowing. Younger and less affluent Americans are less likely than before the recession to own a home, for example, or to have much equity to borrow against if they do own. These are people who have historically been most inclined to borrow and spend.

Older, wealthier homeowners now own a larger share of America’s housing wealth. Yet at their age, they’re less likely to borrow for big purchases or projects.

Partly as a result, Americans have increased spending an average of just 2.3 percent a year since 2009, when the recession ended, just two-thirds of the historical norm. Because consumer spending drives about 70 percent of the economy, that weaker pace has hobbled growth.

The economy hasn’t grown 3 percent or more — its long-term norm — for a full year since 2005. Other factors are also slowing the economy, like retirements by the vast generation of baby boomers. But weak consumer spending is a significant drag.

“The previous behavior of using housing debt to finance other kinds of consumption seems to have completely disappeared,” William Dudley, president of the New York Fed, said in a speech earlier this year. “People are apparently leaving the wealth generated by rising home prices ‘locked up’ in their homes.”

Americans borrowed an average of $181 billion annually against homes from 2000 through 2003, before the reckless borrowing of the housing bubble, New York Fed economists found. But from 2012 through 2015, as housing recovered, they borrowed just $21 billion annually on average.

Banks now must hold more money in reserve for each home equity credit line they extend. So home equity lines have become a less attractive business for banks than loans that require lower reserves.

Mortgage buyers Fannie Mae and Freddie Mac can now send home loans that default back to the banks that provided them, thereby inflicting losses on the banks. Fannie and Freddie also view cash-out refinances as riskier now and have imposed higher fees to guarantee them. This makes such loans costlier for banks and consumers.

Banks are increasingly focusing on the most credit-worthy borrowers. It now requires an average credit score of 780 to get a home equity loan, up from 730 before the housing bust, the New York Fed estimates. Barely 30 percent of households have scores that high.

“There’s been a really striking shift, with a whole class of scores that are no longer getting loans,” said Bill Nelson, deputy chief economist at The Clearing House, a banking trade group.

The use of homeownership debt can be healthy, Dudley noted. Most people earn more as they age and their careers progress. To borrow against future income, they need to use home equity as collateral.

And more people would like to do so. In the summer and fall of last year, about one-third of banks reported rising demand for home equity credit lines, according to the Fed. But rejection rates for such loans have also risen.

Benjamin Keys, a real estate professor at the University of Pennsylvania, notes that just 42 percent of mortgage refinances last fall were “cash outs,” compared with roughly two-thirds during the pre-bubble period. Keys suggested that enabling banks to lend more to households with somewhat weaker credit and easing requirements on income documentation would be beneficial.

“But it’s a slippery slope,” he added. “We don’t want to go down that path that has made the mortgage market much safer.”

Looser regulation wouldn’t address another constraint on borrowing: Homeowners with the most equity are likelier to be older and wealthier than before the recession and so less likely to borrow for major purchases. In early 2016, Americans over 60 owned one-third of housing equity, up from one-fifth in 2006, according to New York Fed economists. And homeowners with credit scores above 780 own half of all housing equity, up from 40 percent a decade earlier.

In addition, the proportion of mortgages of less than 30 years has jumped. Nearly 38 percent of refinancings last year were for less than 30 years, the Mortgage Bankers’ Association said, up from 29 percent in 2011. Shorter mortgages force homeowners to save more and spend less by requiring higher payments.

Dynan also notes that given the wild fluctuation in home prices since 2006, some Americans now see housing wealth as akin to volatile assets like stocks and may be more hesitant to spend it.

Of course, there’s a positive side to the trends: More saving and modest spending means households are in rosier financial health, which should help sustain the economy.

And with mortgage rates rising, more homeowners may choose to renovate homes rather than buy new ones. That could lead more creditworthy homeowners to seek home equity loans to finance projects.

“If households and lenders again become comfortable with financing consumption with debt in addition to income, this will provide additional support” to the economy, Dudley said.