Federal financial regulators are hoisting cautionary red flags about the most popular real estate equity-tapping tool in the American marketplace: Home equity lines of credit.

New home equity lines, or HELOCs as lenders call them, have mushroomed in recent years. Whereas in 1990 American banks and thrift institutions originated approximately $85 billion worth of HELOCs, during the first half of 2004 alone they originated over $416 billion. This year could prove to be the first $1 trillion-plus HELOC year in new origination volume.

Though fixed-term home equity loans -- second mortgages -- were the primary form of home equity lending in the 1980s and much of the 1990s, floating-rate HELOCs now hold an 80 percent market share versus 20 percent for conventional fixed-term equity seconds.

That "explosive growth" is not surprising, according to a new report from the Federal Deposit Insurance Corp., because HELOCs are convenient, low-cost tools to convert frozen home equity into spendable cash. However, warned the FDIC, lenders' hypercompetitive efforts to originate greater volumes of HELOCs -- with looser underwriting standards and more generous loan terms -- could cause "loan performance to deteriorate." In blunt terms, the FDIC said it is worried that higher numbers of credit line borrowers could slip into delinquency on their payments if market interest rates continue to rise and home value appreciation rates level off or decline, as is inevitable in some markets.

Already "subprime" HELOC homeowners with below-average credit scores are registering a 5.43 percent delinquency rate on their outstanding lines, and "rising interest rates may push this (number) higher," said the FDIC. Increasingly attractive credit line terms are also pulling in vast numbers of homeowners into HELOCs who never used equity financing in the past. Among the loan features cited by the FDIC:

• Automatic upward adjustments in credit line limits as home equity grows year by year. Some banks offer programs that raise borrowers limits based solely on increases in home price indexes for their local markets, or online annual "automated valuations" of the property that involve no direct inspection or human evaluation of the property. Other lenders offer 100 percent combined loan-to-value programs (first and second liens), essentially allowing consumers to borrow as high as 100 percent of their home equity.

• Interest-only payment terms, allowing homeowners to avoid principal reduction and pay only interest until a set date for a balloon repayment, years down the road.

The FDIC also expressed concern about rising drawdown rates against credit line maximums, which hit 48.3 percent earlier this year, up substantially from earlier periods. "Utilization (of the available credit limit) is an important metric for lenders to watch," cautioned the FDIC, "because a rise could indicate that consumers are drawing more on (their) HELOC for spendable cash and are in a weaker position" to repay.

The FDIC's red flags came in the wake of the release of other federal data reporting that aggregate mortgage debt now stands at 72 percent of total household debt -- an all-time high -- and that home price appreciation went off the historical charts in select markets last year, ranging as high as 42 percent in Las Vegas.

Published: December 13, 2004

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Kenneth R. Harney writes an award-winning, nationally-syndicated column on housing and real estate from Washington, D.C. He is also managing director of the National Real Estate Development Center, a professional education company. He is a past member of the Federal Reserve Board's Consumer Advisory Council, a committee that by federal statute reviews all Fed actions on home mortgage, consumer credit and banking industry regulation. He served as a member of the U.S. Department of Housing and Urban Development's Working Group on Computerized Loan Origination (CLO) systems, and is a member of the Editorial Board of the Fannie Mae Foundation's journal, Housing Policy Debate. He is the author of two books on mortgage finance and real estate.