Credit Crisis Spills into Every Nook and Cranny

The epidemic of bad mortgage credit that was once isolated to the housing industry is now threatening to adversely influence the ability to borrow money for a variety of other consumer loans, including those for debt consolidations, autos, and credit card purchases.

Americans have been piling on debt. Real estate went soft, leaving them with less credit and fewer assets, but they responded by pawning their homes. According to the mortgage industry publication Inside Mortgage Finance, consumers in the U.S. have taken out $2 trillion in home equity loans. Many of them have no idea how they'll pay them back.

Debt consolidation strategies

One solution is to take high-interest debt balances and pay them off with a lower cost loan. This strategy of debt consolidation produces immediate relief. Pay off an 18 percent loan by taking out an 8 percent loan, for instance, and you can quickly save 10 percent. But many homeowners have been using home equity for debt consolidation loans, and this effectively depletes property value. Even selling may not solve the problem, because the homeowner might not generate enough money to pay off the first and second mortgages. The lender then forecloses and the property owner loses the home-perhaps just to pay off a pesky credit card.

Passing the crisis to consumers

One reason the subprime crisis happened is because lenders figured out a way to package loans and resell them as "mortgage backed securities" on Wall Street. When borrowers defaulted, investors stopped buying the securities, and the source of credit dried up. Lenders suffered losses and also a drying up of available funding for new loans, so they passed the crisis along to consumers by tightening loan application guidelines, raising fees and rates, and eliminating some of their most popular loan products.

At first it was thought that those who didn't have subprime mortgages would escape the problems. Then, the trouble engulfed prime mortgage borrowers and spread to HELOC loans. Now, financial institutions have revealed that the packaging of loans for sale on Wall Street was not limited to mortgages, but also involved a variety of other consumer loans like those for autos, credit cards, and college financing. Many say that the next wave of credit problems will involve them.

New rules for credit cards

Credit card companies have already changed their rules, and some cardholders have seen the interest rates on their outstanding balances jump by as much as 100 percent. Banks justify these severe changes by saying that they're reevaluating the credit scores of their customers and using more stringent standards. Those who don't pass the litmus test are penalized as a way to protect lenders. Lines of credit are being revoked, and consumers who were thinking of doing a debt consolidation loan with home equity or some other convenient source of funds can forget about it. Although on the surface the game may look the same, the rules have been altered so drastically that it seems that consumers are destined to lose.