When James Chou's credit card debt began to spin out of control a few years ago, he turned to a home-equity loan to pay it off. It proved to be a wise choice. Interest rates on home-equity loans are generally lower than on credit cards. What's more, the interest is tax-deductible, unlike credit card interest.
That was a few years ago, and Chou, a purchasing manager in Lawrenceville, Ga., looks back with relief.
"I was very lucky," he says.
Today, many people don't have that option. With the turmoil in the mortgage market spreading, homeownership is no longer an easy refuge from credit card debt. That's because some lenders have stopped offering home-equity loans. Others have tightened lending standards so that those with less-than-perfect credit scores can't always qualify. And home prices in many areas have dropped, reducing the equity that homeowners can borrow against.
Until recently, many Americans, like Chou, took advantage of their homes' value to lighten their credit card debt. Since 2001, more than $350 billion in card debt has been shifted into home-equity loans or into mortgages refinanced by homeowners, says Robert Manning, a finance professor at Rochester Institute of Technology.
But now, more Americans are falling behind on their card payments. Credit card delinquencies are starting to rise. And the shrinking availability of home-equity loans is one big reason.
Loss of a safety valve
Until the mortgage credit crunch began to ripple through the credit markets, many Americans managed to keep up with minimum credit card payments. With home-equity loans drying up for some, consumers have lost an important safety valve, says Tamara Draut, director of the economic opportunity program at Demos, a non-profit research institute.
"As more homeowners have run out of options, it's likely that they will turn to credit card debt," Draut says. "Household incomes have not been rising to keep up with basic costs."
In the first five months of the year, credit card delinquency was 3.77% higher than a year earlier, according to Moody's, (MCO) the credit-rating agency. And late card payments surged 30% during that period.
"With sinking home values, higher interest rates and tighter underwriting, many consumers may not be able to consolidate credit card debt," says Robert McKinley, CEO of CardTrak.com. "And paycheck-to-paycheck families with a mortgage payment that resets to a much higher rate may not be able to pay for their credit card debt."
From 2000 to 2006, the average card debt carried by Americans grew from $7,842 to $9,659, according to CardTrack.com. That totals $850 billion in credit card debt for 88 million Americans, it says.
Now that many Americans are facing a home mortgage, a home-equity loan and costly credit card payments, a perfect storm is brewing, Manning says. Consumer debt has grown faster than many families' financial assets have. And the collapse of the subprime market has eliminated many borrowing options.
Seven years ago, Isaac Caballero, who lives with his wife and three children in the Orlando area, came close to ruin. That's when he took out a home-equity loan to pay down $40,000 in credit card debt. Afterward, instead of holding back on his credit card bills, he ran them up again, and his card debt hit $80,000.
"I blame myself because we were not disciplined enough to stop the spending habits we had," says Caballero, who sells products to hospital labs. "We ended up with two mortgages and more credit card debt."
He had to sell his home to pay some of the card debt. He then relied on a credit-counseling firm to renegotiate the balance. At least his home had grown in value, and he was able to quickly sell it.
Caballero now has a good job, owns a home and is no longer in debt. "I would love to be able to help people who are now in the shoes I had," he says.
But it's harder now. It's not so easy for Americans to simultaneously pay off a home-equity loan, make their credit card payments and save their homes. Consumers who have less-than-stellar credit might not be able to get loans now.
Many experts had encouraged homeowners to use a home-equity loan to pay off their credit debt. (The average rate on a $30,000 home-equity loan is 8.06%, compared with 14.38% for a standard credit card, according to Bankrate.com's (RATE) weekly national survey.)
But other analysts have always considered it a risky move. "If you hit a financial collapse, unsecured credit card debt can be erased, but a home-equity loan can no longer be wiped out through bankruptcy," Draut says.
Despite the mortgage meltdown, credit cards are still available, and average rates have inched up only slightly. Card issuers are growing more cautions, though.
"They're nervous about what the mortgage problems can mean for them," says Mark Zandi, chief economist for Moody's Economy.com. "So credit card lenders are not going to tolerate missteps by a borrower."
Tighter lending standards
Consumers with good credit scores who pay on time remain desirable. But card issuers will quickly raise rates and shut down a line of credit if there is any late payment or sign of a problem, experts say.
Punitive interest rates charged by the major card issuers, meantime, have reached nearly 33% - an all-time high, according to CardWeb.com.
"Card holders with deteriorating credit scores and credit problems are being hit with these extremely high interest rates, which simply exacerbate the credit meltdown," McKinley says.
It's a scary time for some consumers, especially if they've lost a job or have spent too extravagantly. More than one-third of credit card holders acknowledge using their cards for purchases they can't afford, according to a report issued by CreditCards.com, a consumer website.
The squeeze in the mortgage market means late card payments could surge further.
"When consumers are faced with the choice of making a utility payment to avoid having their electricity being shut off, or making a mortgage payment to avoid losing the most prized asset, their home, then they are usually going to make such payments a higher priority than paying their credit cards," says Curtis Arnold of CardRatings.com, a consumer website.
By Christine Dugas, USA TODAY