Consumers turn to plastic as home loans slow

 @ibtimes on September 11 2007 3:37 PM

Consumers are carrying a record $907 billion in credit card debt, and that looks likely to jump now that the housing slump has blunted another popular financing tool -- home equity loans.

Americans cashed out hundreds of billions of dollars in home equity as credit came cheap in a five-year housing boom that ended about 18 months ago.

Now, with the subprime mortgage mess triggering tighter financing terms and home prices falling in some regions, the home-as-ATM trend is slowing, threatening to curb the consumer spending that drives two-thirds of the U.S. economy.

The home equity spigot has been really shut off over the last nine months or so. With (home price appreciation) stagnating, borrowers have not had the opportunity to refinance as much as they had, or cash out for spending needs, said Joe Astorina, securitization analyst at Barclays Capital.

Growth in credit card receivables is offsetting the decrease in home equity borrowing for consumer spending. Consumers are using their credit cards again, said Astorina.

The problem is, credit cards typically come with steeper interest rates and fees, and usually a much lower limit on borrowing. And if credit terms tighten further and card issuers clamp down, consumers will have little choice but to cut back on spending -- a worrisome thought for the U.S. economy as the all-important holiday shopping season approaches.

BUY NOW, PAY LATER

U.S. Federal Reserve data released on Monday shows that as of July, consumers had racked up $907.4 billion in revolving credit, which is made up of credit and charge cards.

That was up 6.6 percent from a month earlier, bringing the annual growth rate to 6.5 percent -- more than three times the level for nonrevolving credit, which includes closed-end loans for things like cars or college education.

In the fourth quarter of 2005, when interest rates were low and the housing market was enjoying a rally that some real estate experts deemed unstoppable, homeowners extracted about $105.5 billion from their home equity.

By the first quarter of 2007, that figure had fallen to $67.9 billion, according to data from James Kennedy, a Fed researcher who co-authored a recent paper on equity withdrawal with former Fed Chairman Alan Greenspan.

Households have apparently substituted credit card debt for mortgage equity withdrawal, said Haseeb Ahmed, U.S. economist with JPMorgan in New York.

The acceleration in revolving credit growth over the past year underscores downside risk to the consumer from recent tightening in lending standards.

For the U.S. economy, which is already showing signs of strain, judging from a shockingly weak August employment report released last week, consumer spending is vital to avoiding a recession.

Economists disagree on how significantly home equity loans contributed to consumer spending in recent years, but there is no question that it drove at least a portion as homeowners took advantage of low interest rates.

As that spending shifts to credit cards, financing won't come as cheap. According to the Fed, the average interest rate on credit cards was 13.46 percent in May, the most recent month for which data was available.

The national rate for a $30,000 home equity loan was 8.43 percent, according to tracking firm Bankrate.com.

In a sign of how credit card usage has risen, issuance of securities backed by credit card assets is up 25 percent at $61.4 billion this year. If that pace keeps up, this year's total should easily eclipse the $65 billion worth of those securities sold in 2006.

The risk is that as debt-laden consumers -- particularly those with poor credit who are already struggling to pay mortgages -- pile more purchases onto plastic, they will get in over their heads and bad loans will mount too.

Banks are watching closely for signs of trouble, although so far consumers seemed to be holding up.

Liam McGee, head of consumer banking at Bank of America Corp, said it was too early to determine how the credit crunch would affect consumers, but already the bank was seeing a decline in spending on discretionary items like recreation.

The most recent performance data for July showed credit card asset-backed securities portfolios are still strong, with historically low rates of loans that banks don't expect to be repaid -- known as charge-offs.

At this point, we have yet to see negative pressure on portfolio performance directly related to the subprime mortgage crisis, Deutsche Bank said in a research report.

(Additional reporting by Jonathan Stempel in New York)

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