The Next Time Bombs? Credit Card Debt/HELOC Loans

The collapse of housing has created tremendous pressures in other areas of the economy. When the suprime crisis began everyone thought that it would be contained to subprime. As things continue to deteriorate it became obvious that the credit crunch was spreading into all areas of financing.

I believe credit cards will be the next shoe to drop because home equity loans are being pulled from hundreds of thousands og homeowners as the banks continue to hoard cash to stay solvent. These loans(also known as HELOCS) were the housing ATM cards that allowed people to spend like Donals Trump when they should have been living within their means.

This is a big problem because according to the Fed. US consumers have about $880 billion dollars in credit card debt. I expect a lot of this debt to end up defaulting. We are already seeing signs that people are falling behind on their credit card payments. Here are some great examples from the Hoffman Brinker and Roberts law firms website:

"In 1968, consumers’ total credit debt was $8 billion (in current dollars). Now the total exceeds $880 billion.(SOURCE: Federal Reserve Bank)"

According to the Federal Reserve Bank, 40% of American families spend more than they earn.(SOURCE: www.federalreserve.gov)

In October 2007, credit card debt that was at least 30 days late totaled $17.6 billion, up 26% from October 2006. Some credit card companies, including Advanta, GE Money Bank and HSBC, are reporting a 50% increase in accounts that are at least 90 days late compared to the same time last year(SOURCE: Rachel Konrad and Bob Porterfield, Associate Press Writers)"

So as you can see the problem is already bad. Notice that some banks are now reporting a 50% increase in accounts that are 90 days late.

Here is why it will get much worse.


HELOC LOANS ARE VIRTUALLY DISAPPEARING


Here is a nice graph showing how much mortgage debt the average American has taken on versus credit card debt. Look at the last 7 years. Can you say housing bubble?


The New York Times had a great article today describing how the banks are sending hundreds of thousands of letters to homeowners announcing they are slashing their HELOCS in half or more. Many of these letters are being sent to areas that have seen the highest price drops in housing due to the fact that the banks are worried that the equity is not there to support the home equity loan.

Some pieces from the New York Times followed by my take:

"Reeling from losses on their wretched loan decisions of recent years, lenders are preventing borrowers with pristine credit and significant equity in their homes from tapping into credit lines that they paid dearly to secure.

In the last 30 days, lenders have sent several hundred thousand letters advising borrowers that their home equity lines of credit are frozen, estimated Michael A. Kratzer, president of FeeDisclosure.com, a Web site intended to help consumers reduce fees on home loans.

Major lenders — including Washington Mutual, IndyMac Bank and the Greenpoint Mortgage Unit of Capital One — say that declining property values are prompting the decisions to cut off credit."

"But these actions are being taken even in areas where property prices are rising, Mr. Kratzer said. What’s worse, the letters provide no explanation for how the lenders determined that the property values underlying the equity lines had fallen."

Borrowers who have an excellent credit score may also find that status hurt when a home equity line is frozen. That is because when a lender suddenly caps a $50,000 line at $25,000, the borrower will appear to have tapped the entire amount of the loan, a factor that can reduce a person’s credit score."

My Take:

Wow isn't this a raw deal for the homeowner. Their HELOC'S are getting cut in half and on top of this it may hit their credit score because it looks bad on a credit report. As you can see from the graph above mortgage debt dwarfs credit card debt. A good chunk of this debt are HELOC's.

So what happens going forward? People will start running up their credit cards because their HELOC's were cut in half. This is going to crush consumer spending because people have lost significant borrowing power. Many will then be forced max out their credit cards because they can no longer depend on their HELOCS to buy their Hummer.

As these distressed homeowners who can't afford their mortgages lose their options for borrowing it will be be DEFAULT TIME! This will result in additional losses of several hundred billions on credit cards alone for banks at a time when they are already in distress or insolvent.

There will also be significant losses on these HELOCS because when a bank forecloses, the original loan for the house gets paid first first. The HELOC gets paid second. So if the foreclosure sells for less than the original loan amount then the HELOC never gets paid back!!

This is why this credit crunch is not over and shoe drops like these will further devastate the banks. This could wipe out many banks. It will also result in even tighter lending standards which will further drop housing prices. Sit back and relax folks. Your houses are getting cheaper by the day.