Grandpa scanned his bookshelves. "Missed Fortune," a book about growing rich through excessive mortgage debt, didn't seem appropriate for innocent ears. "The Loan Officer's Practical Guide to Residential Finance" would put the kids to sleep, all right, but for the wrong reasons. Grandpa stood there a long time, searching in vain for a children's book.
Grandpa was a mortgage man. Had been, for decades. He'd gone through all the noise: the skyrocketing rates of the early 1980s, the crash of the early 1990s, the boom of the early 2000s. The ups and downs had narrowed his focus, so the only tomes on his shelves were mortgage books, a Bible and an operator's manual for a belt sander. He was going to have to think up a bedtime story off the top of his balding head.
Hud said: "Don't tell us that story about the mean government bureaucrat who threw the nice mortgage broker in a dungeon for helping people with boo-boos to their credit. That one scared me."
Sallie said: "You're not going to explain amortization again, are you?"
Shaking his head, Grandpa tucked the kids in, sat on the end of Hud's bed and began the Tale of the Equity Loan and the HELOC:
"Once upon a time, way back in the middle of 2004, when you spoke only baby talk, Hud, a home equity line of credit was a lot cheaper than other kinds of mortgage debt. Home equity lines of credit were so popular that people gave them a nickname: HELOC."
Sallie said: "Like Jennifer Lopez is called J-Lo."
"Exactly," Grandpa replied. "Back in June 2004, before the Federal Reserve started raising short-term interest rates as a preemptive strike against inflation, the average rate on a HELOC was just 5.13 percent, compared to 6.3 percent for a 30-year, fixed-rate mortgage, or 7.83 percent for a closed-end home equity loan.
"Back in those days, HELOCs were as popular as Bratz and Pokemon. People were barging into my office and demanding HELOCs. One man almost got his eyes gouged out when he tried to jump in line ahead of a woman who was knitting a sweater while she was waiting to see me.
"But in the middle of 2004, the Fed started raising the federal funds rate every six weeks, and that meant that the prime rate was going up every six weeks, and HELOCs are indexed to the prime rate, so HELOCs were going up, too. By the end of 2004, what do you think happened?"
Hud, wide-eyed, whispered, "What?"
"At the end of that year, the average HELOC rate was just three-tenths of a percentage point lower than the 30-year rate. Just six months earlier, it had been almost one and a quarter percent lower.
"So people were refinancing their mortgages like crazy and they were taking out these big ol' HELOCs to pay off their credit cards or buy cars or fix up their houses. That was the year when I bought you both lots of expensive Christmas presents.
"Well, that mean old Fed kept raising short-term interest rates every six weeks for two whole years. It was like being spanked 17 times in a row! By the beginning of 2006, the average HELOC rate was more than a percentage point higher than the 30-year fixed. Some people were paying off their HELOCs, and some were taking advantage of hybrid HELOC products that allowed them to set a fixed rate on a portion of their balance. And some people kept their HELOCs but they were all grumbly about those high interest rates.
"It got even worse as the year wore on. By this fall, the average HELOC rate was almost two percentage points higher than a 30-year fixed. Some people were even refinancing to a higher rate on their 30-year fixed so they could consolidate their HELOC debt into it and thereby get a lower blended rate."
Hud's eyelids were fluttering. Sallie said, "What about home equity loans, Grandpa?"
"They gradually went up about half a percentage point through 2006," Grandpa said. "People didn't talk much about home equity loans, but customers continued to get them. In the spring, HELOC rates actually passed home equity loan rates. You would think that would get people to switch to home equity loans, but HELOCs have a big advantage: for the first 10 years, you have to pay only the interest on a HELOC. You have to pay interest plus principal on a home equity loan. And a lot of Americans aren't interested -- ha ha! 'Interested,' get it? -- in paying principal."
Sallie snuggled her bunny and said sleepily: "Did someone tell those mean people at the Fed to knock it off?"
"Yes. At the end of June they stopped raising the federal funds rate every six weeks. HELOC rates stabilized at right around the prime rate of 8.25 percent, while home equity loan rates continued to rise and mortgage rates steadily fell."
Grandpa paused, trying to come up with a moral to the story. He needn't have worried, as both children were breathing deeply, eyes closed. He carefully arose from the end of Hud's bed, turned off the light and left, leaving the bedroom door open just a crack. |
