Consumers Maxing Out their Home Equity

It's a sign of the times: Economic data indicates that homeowners may be padding their savings accounts with money borrowed from their home equity lines of credit (HELOC).

A year ago, gift shoppers were wildly snapping up Nintendo Wii game consoles to avoid getting caught by the inevitable holiday toy shortage. This year, however, consumers aren't as worried about out-of-stock toys as they are about out-of-cash checking accounts.

Cash hoarding nation

The greenback is poised to become 2008's hot holiday commodity. U.S. banks have been hoarding their cash for months, and now consumers are beginning to follow suit. In the final weeks of the third quarter, homeowners increasingly pulled money from their home equity lines of credit (HELOC)-even as savings rates increased, and consumer spending declined.

Because approved HELOCs allow for cash advances without explanation, there's no set of data that can pinpoint how the home equity loan funds are being used, or even why they're being borrowed. It's significant, however, that the increased borrowing coincides with higher savings deposits, reduced credit card usage, and generally depressed consumer spending. Those factors indicate that homeowners may be simply shoring up their cash reserves with cheap home equity debt.

Borrowing before it's too late

Homeowners may also be motivated by the fear that their available home equity credit will disappear, just when they need it most. Prompted by declining home values, mortgage lenders have been slashing HELOC limits, a trend that's been covered extensively by the financial media. Meanwhile, homeowners are also getting peppered with mass layoff announcements and an increasingly dismal employment outlook. Drawing down HELOC funds now, before that availability is taken away, may be a proactive strategy to defend against the possibility of income loss.

Low rates create immediate emergency funds

The prime rate is approximately 4 percent, the lowest it's been since 2004. Some analysts expect the Fed to vote for another prime rate reduction in December, which would take the rate down to levels not seen since 1958. Since most HELOC rates are tied to the prime, these historically low rates are another argument for increased home equity loan borrowing. If the prime stays at 4 percent, an advance of $20,000 on a prime-plus-zero HELOC would cost the homeowner $800 a year in interest. Savvy homeowners can offset most of those interest costs by sticking the 20 grand in a high-yield savings account that earns 3 percent or more.

The risk, of course, is that these low interest rates aren't sustainable. When rates do tick up, homeowners who spend their HELOC money may find themselves struggling to keep up with the higher interest costs. Those who keep the money on deposit will have to decide just how much they're willing to pay for that peace of mind.

Meanwhile, retailers may be disappointed by this year's holiday run, unless they can find a way to stock their shelves with the product consumers really want: cash.