Home Equity Loans Are on the Rise...Should We Be Worried?

Before you go, we thought you'd like these...
Before you go close icon

According to recent data, the home equity loan market is rebounding. Even though outstanding balances on home equity lines of credit (HELOCs) are more than 26% below their 2009 peak and have dropped for 10 straight quarters, it looks like the amount of new originations is on the rise.

Home equity loans were a major factor in the pre-crisis spending frenzy in the U.S., so should we be worried about this, or is it different this time around?

Still way below the peak
The dollar amount of new home equity credit lines originated grew 20% last year to $92.5 billion, but is far below what we've seen in years past. New originations peaked at $383.8 billion in 2006, and began to drop until 2010. Since 2011, originations have been on the rise once again. However, even though originations are on the rise, the total outstanding lines of credit continue to fall, for now.

US Banks Home Equity Lines of Credit Chart

What that tells us is that current lines of credit are being paid off, cancelled, or written off faster than new lines of credit are being originated. This makes sense given the massive volume of HELOCs originated in the pre-crisis years.

This may be a backlog of business
One reason we're seeing an increase in new HELOCs is the sharp recovery in home prices in many parts of the country. According to the S&P/Case-Shiller Composite 20 Index, average home prices are up about 25% from their lows in major U.S. cities.

Case-Shiller Home Price Index: Composite 20 Chart

This means that people now have more equity they can tap into, and may take the opportunity now to borrow money for things they have been putting off. For instance, many home equity loans are taken out to finance repairs or improvements to the home. If someone didn't have sufficient equity in their home, they could put the repairs off until the equity improved. This type of delayed borrowing may be what we're seeing now.

As long as standards remain reasonable, we'll be alright
Most banks will allow customers to borrow 80-85% of their home's value through a combination of a mortgage and a home equity loan. So, if your mortgage balance is 70% of the value of your home, you should expect to be able to borrow 10-15% of your home's value in the form of a home equity loan. The idea here is that if you can't pay the loans back, the bank could sell your house for more than you owe and recoup their money.

However, it wasn't always this way. During the mid-2000's it was relatively easy to borrow up to 125% of your home's value. In many cases, consumers would literally put no money down on a home, and then proceed to borrow up to 25% of its value to fuel their spending habits. When you consider the inflated values of homes during that time period, it's easy to see how this got out of control quickly.

So, no matter how much we see home equity lending increase, as long as people are limited to borrowing considerably less than their homes are worth, there is no cause for panic. When responsibly used, home equity loans are essential to a healthy real estate market, as they allow homeowners to pay for repairs and improvements on their homes.

They are not, however, intended to let people afford cars and vacations they otherwise couldn't. Until we see that happen again, and with lines of credit of more than the home's value, the recovery is still in good shape.

What will this company mean to the banks' HELOC business?
There's a brand-new company that's revolutionizing banking, and is poised to kill the hated traditional brick-and-mortar banks. That's bad for them, but great for investors. And amazingly, despite its rapid growth, this company is still flying under the radar of Wall Street. To learn about about this company, click here to access our new special free report.

The article Home Equity Loans Are on the Rise...Should We Be Worried? originally appeared on Fool.com.

Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Copyright © 1995 - 2014 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

Read Full Story

Want more news like this?

Sign up for Finance Report by AOL and get everything from business news to personal finance tips delivered directly to your inbox daily!

Subscribe to our other newsletters

Emails may offer personalized content or ads. Learn more. You may unsubscribe any time.

From Our Partners