Call it the piggy-bank conundrum: A homeowner watches as his neighborhood turns hip, lifting property values around him. He then realizes the dwelling he purchased years ago is suddenly worth much more today. But because that increased value is based on the sale of a building and not, say, a stock — he still would need somewhere to live, likely as expensive — the windfall is like a highway mirage, frustratingly out of reach.
Enter the home equity loan. For decades, it’s allowed homeowners to use little but the roof over their heads as collateral for tangible cash. Typically in the amount of about 20 to 30 percent of a home’s value, home equity loans were used to upgrade the kitchen or add a deck — or in more recent years, pay off credit card debts.
But uncertainty in the market as a result of the credit crunch and fallout in the subprime mortgage industry has possibly weakened the assets upon which these home equity loans are based. This breed of second mortgage is looking increasingly flimsy, and lenders are starting to say no.
The losers, according to real estate brokers and lenders, are New York City homeowners in marginal neighborhoods, where values are quickly plummeting. These prospective borrowers are the same homeowners being rejected in their attempts to refinance their subprime mortgages because of their less-than-stellar credit ratings and limited earning potential.
From the perspective of many lenders, home equity loans are now way too risky. In the event of foreclosures, which are on the rise in the outer boroughs, lenders can rarely collect on them since the primary mortgage holder gets first dibs on the property.
At the same time, the secondary market for home equity loans, which comprises Wall Street investment banks that use mortgages as collateral for tradable securities, is nearly flat, and buyers and sellers are losing interest.
Lenders are trying to tighten their standards to please those same investment banks by creating attractive securitized loan pools. But they say it’s a tough sell.
“Second mortgages are a dirty word today,” said Michael Moskowitz, founder and president of Equity Now, a Manhattan-based lender.
In the last few months, lenders who got stuck holding them were forced to resell them for steep discounts, like 10 or 20 cents on the dollar, he said, but not any more.
“Now we know there is no more liquid market for them,” Moskowitz said.
Before the collapse, home equity loans represented about 10 percent of his business, or what he said is about $26 million a year. Now Moskowitz sees them slipping by half to about 5 percent, or $13 million.
(In comparison, Equity Now’s mortgage issues are off only about 25 percent, even with tighter scrutiny of borrowers’ financial wherewithal, Moskowitz said.)
National City Bank, for example, as per its third-quarter filings, said it will cut back on home equity loans, and so will Credit Suisse, according to lenders. Two silver linings, though, are that Wells Fargo and Citibank continue to underwrite them, Moskowitz said.
“This is asset-based lending, so as soon as the value of the assets dips, people freak,” said Moskowitz.
In New York’s recent real estate boom, home equity loans became a common tool to avoid paying mortgage insurance — a more expensive proposition — which kicks in when the buyer takes a loan for more than 80 percent of the property’s value.
Even if the buyer lacked the cash for that 20 percent slice, he could piggyback off it with a second home equity loan from a different lender and thus cover his share, according to real estate and mortgage brokers.
But if the buyer isn’t well-screened in advance, those kinds of piggyback loans can be risky, because paying two monthly bills is more of a burden than one, said Melissa Cohn, the owner and president of Manhattan Mortgage, a metro-area mortgage broker.
Cohn’s firm will originate $4 billion in mortgages this year, she said, with at least 5 percent, or $200 million, in the form of home equity loans. That ratio won’t change significantly going forward, she predicted, since her borrowers have generally always been carefully screened in terms of their income and assets.
In fact, with sales numbers and prices dipping, altering the refinancing landscape, these underwriting standards are more important than ever, Cohn said.
“Everything changed over the past 60 days,” she said in late September.
High-net-worth individuals will continue to use home-equity loans to buy city-area homes, said Janice Silver, an executive vice president of Bellmarc Realty who focuses on the Upper East Side.
This is especially true among older couples who live in the tonier suburbs, like Greenwich or Bedford, and are looking to buy New York pied- -terres.
Their local bank, with whom they probably have a longstanding and personal relationship, will typically issue them the standard 20 percent home equity loan without any special paperwork, Silver said.
A $5 million suburban home, then, could yield a $1 million home equity loan. And, banks mostly aren’t worried about repayment because even in the direst of short-term market conditions, she said, a house won’t drop 80 percent in value.
Co-ops, though, are a different story, according to Silver, as their boards generally don’t like the loan-on-loan arrangement. And they will know about it, as any board package usually spells out the details about how a purchase will be structured.
Home equity loans are sometimes used to buy more real estate — so the suburban buyer will buy a city apartment on the basis of a home equity loan on the suburban home.
“These types of buyers use a home equity loan because they don’t want to liquidate an asset like stocks or bonds,” Silver said, though she sees only about two purchases of this type a year.
Plus, closing with cash avoids having to pay mortgage taxes, which can total 2 percent of a deal, according to Silver.
“And all they need to do,” she said, “is to make a phone call.”