An Aggregate Investigation of the Demand for Home Equity Credit

By Dow, Benjamin L.,, III; Newsom, Paul D. | Journal of Commercial Banking and Finance, Annual 2005 | Go to article overview

An Aggregate Investigation of the Demand for Home Equity Credit


Dow, Benjamin L.,, III, Newsom, Paul D., Journal of Commercial Banking and Finance


ABSTRACT

Home equity credit has continued to grow in importance to both financial institutions and consumers. Financial institutions find home equity loans attractive because of low delinquency and foreclosure rates and consumers are drawn to home equity credit because of the potential for interest tax deductibility. However, most of the research related to home equity credit focuses on surveys of consumers and financial institutions. This paper proposes that financial institutions may find it more beneficial to look at aggregate variables that influence the overall demand for home equity credit in order to more cost effectively utilize home equity marketing campaigns. Over the 1987 to 2001 sample period, the results from a time series analysis indicate that aggregate levels of home improvement expenditures and economic business cycle effects may be the best indicators of the demand for home equity credit.

INTRODUCTION

According to the Federal Reserve Board's 2001 Survey of Consumer Finances, 67.7 percent of U.S. households were homeowners and 44.6 percent of households had some type of home-secured debt, including first and second mortgages and home equity loans and lines of credit secured by the primary residence (Aizocorbe, Kennickell, and Moore, 2003). More importantly, the 2001 survey indicates that 32.1 percent of households with home-secured debt used the borrowed money for a purpose other than financing their home (Aizocorbe, Kennickell, and Moore, 2003). Collectively, these figures demonstrate the overall importance of home equity as a means by which homeowners can alter present and future consumption, repay other debts, or both.

Historically, home equity had largely gone untapped as a source of funds to alter consumption patterns or repay debt until the Tax Reform Act of 1986. The phase out of federal income tax deductions for interest paid on non-mortgage consumer debt enhanced the attractiveness of using debt secured by one's home for expenditures financed previously with other forms of consumer credit. Currently, the majority of research on home equity lending is conducted by survey research centers. The Federal Reserve Board periodically surveys households about their home equity borrowing, and regulatory agencies collect data from commercial banks and savings institutions on amounts of home equity outstanding. These micro data studies clearly demonstrate historical trends in the use of home equity credit and are useful in identifying changes within the total population that impact borrowing among subgroups. However, the usefulness of time-lagged survey data in marketing home equity credit to consumers is questionable. This paper proposes that financial institutions may find it more beneficial to look at aggregate variables that influence the overall demand for home equity credit in order to more cost effectively utilize home equity marketing campaigns.

HISTORICAL PERSPECTIVE IN MARKETING HOME EQUITY CREDIT

Traditionally, home equity credit takes either of two forms. The home equity loan (HEL) is a closed end loan extended for a specific period that generally requires repayment of interest and principal in equal monthly installments. Such a loan typically has an interest rate that is fixed for the life of the loan. The other form, a home equity line of credit (HELOC), is a revolving account that permits borrowing from time to time, at the homeowner's discretion, up to a specified maximum. The majority of home equity lines of credit have a variable interest rate that is pegged to an index such as the prime rate. The primary benefit of home equity credit to consumers is the tax deductibility of interest payments and lower costs of borrowing. These benefits are offset by the potential foreclosure of one's home if repayment is not made. However, homestead exemption laws may prevent some claims by unsecured creditors against a debtor's home in the event of bankruptcy and range in protection from no exemption (DE) to unlimited exemption (IA, ID, KA, FL and TX). …

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