How rising home values, easy credit put your finances at risk

— -- At the peak of the housing boom, April Lewis-Parks' three-bedroom house in Fort Lauderdale doubled in value. To her surprise, her credit card limits soared even more.

One card issuer more than tripled her spending limit, to $17,000. Another increased her limit 60%, to $16,500. Lewis-Parks' income hadn't risen. Nor had her credit score changed much. "The only thing that went up," she says, "was the equity in the house."

That pop in her credit card buying power was no accident.

During the housing boom, from mid-2001 to early 2006, banks raised card limits at a blistering pace across the nation, in part because of a surge in home equity, much of it now vanished. As home prices ballooned, banks also plied customers with a record number of offers to open new card accounts. Then they guided card borrowers to pay off card balances with artificially inflated home equity, putting their homes at risk.

Today, the mix of high-rate debt and meager home equity has squeezed consumers — and threatens to prolong the economic slowdown. Those are the findings of a USA TODAY investigation, based on analyses of credit card data from Equifax credit bureau, Moody's Economy.com, Synovate Mail Monitor and Mintel Comperemedia.

The consequences are visible. Foreclosures are at record levels. And credit card delinquencies are nearing a six-year high as millions of borrowers struggle to keep up with a record load of revolving debt, mostly on credit cards.

Card issuers extended too much credit, too quickly because of the "phantom equity" in people's homes, says William McCracken, CEO of Synergistics, a financial-services research firm.

In turn, this "reckless extension of credit is contributing to the financial vulnerability that many families are facing," says Travis Plunkett of the Consumer Federation of America.

USA TODAY's analysis of credit card data found that during the housing boom:

• The average credit card spending limit rose a cumulative 17%, to $8,158, after adjusting for inflation, as median pay was declining and living costs were rising. Cardholders have an average of five cards.

• Banks doubled the amount of new credit cards issued to "subprime" customers — those with tarnished credit. This group could least afford to sink deeper into debt yet were most likely to tap additional credit.

• Banks encouraged customers to use their inflated home equity to pay off mounting card balances. In doing so, borrowers converted unsecured revolving loans into debt secured by their homes, which they now stand to lose if they can't pay their bills. Many financially squeezed borrowers ran up more card debt.

Now, even with the economy ailing, banks have continued to expand credit limits. They're also raising more borrowers' interest rates to as high as 30% — at a time the Fed is cutting rates — and collecting a record amount of penalty fees.

Banks are "hoping that in an atmosphere of tight credit, these people will have nowhere to go and be forced to pay high interest on their card balances," says Elizabeth Warren, a Harvard law professor. "It's a straightforward profit calculation."

Willingness to lend

Banking officials dispute any notion that they exploited swelling home values to expand credit limits. They contend that higher card limits between 2001 and 2006 simply made good business sense.

James Chessen, chief economist for the American Bankers Association, says rising home values and a booming stock market made banks willing to lend. "There was rising equity in houses, growing wealth, and the economy was growing quickly," he says.

Joe Belew, president of the Consumer Bankers Association, argues that home value was just one factor — and not the most important one — banks used in deciding how much to expand consumer credit. In raising card limits, Belew says, banks look first to a borrower's ability to repay a loan.

It's "perfectly reasonable" for lenders to look at home equity to decide how much credit to extend, says Mark Zandi, chief economist at Moody's Economy.com, because "The home is the most important asset many households have."

Yet the industry's eagerness to issue mortgages — and to boost card limits simultaneously — created a "double financial bubble," says Robert Manning, author of Credit Card Nation: The Consequences of America's Addiction to Credit.

As home equity and card limits rose in unison, consumers overextended themselves. Banks encouraged consumers to take on "unrealistic levels of credit card debt," Manning says, and then to pay it off with home equity loans.

Kenna and Richard Baker of Des Moines say that as their home's value rose, they were barraged with offers for home equity loans and credit cards. They opened up new credit cards.

They also refinanced their mortgage twice and withdrew cash to pay off existing card bills and make home improvements.

But as the economy weakened and Richard's pay as a delivery driver fell, they used their cards again for necessities. "We had to pay the gas bill on cards one month or we'd get cut off," says Kenna Baker, 44.

Today, the Bakers owe $30,000 on credit cards and $105,000 on a home worth only $63,000. They blame themselves but also say lenders share responsibility for "making it so easy" to borrow.

Tripled limits

The seeds of the mortgage crisis — and the emerging credit card crunch — were planted as housing values began rising at an accelerated clip in 2001. Loose lending standards fueled demand for real estate, driving home prices sky high in many cities, says Paul Bishop, director of research for the National Association of Realtors.

Consumers tapped into a new wellspring of home equity to pay for home improvements, medical costs, even education. And they began using proceeds from lower-rate home loans to pay off higher-rate credit card balances.

As the shift to home equity loans gained traction, card debt slowed. Revolving debt, which had grown at a sizzling 12% annual rate in 2000, slowed to a meager 3% rate in 2005, near the peak of the boom.

Banks moved quickly to shore up their sagging card business. They blanketed consumers with a record 25.5 billion credit card offers from 2001 to 2005, partly to "compete with home equity loan (offers) in the mailbox," says Andrew Davidson, vice president at Synovate Mail Monitor, which tracks such data.

Banks also sent existing card holders approvals for huge step-ups in their spending ability. Banks know "you don't make money unless you get (consumers) to transact more, and one way to do that is to raise the credit card limits," says John Ulzheimer, who's worked as a manager at Equifax and Fair Isaac, creator of the FICO credit score.

Lewis-Parks, of Fort Lauderdale, says Chase and Bank of America raised her credit limits in 2006, shortly after she took out a larger mortgage on her home and extracted cash to pay off credit card bills and other debt. Banks, she argues, should first ask consumers if they want the additional credit before raising their credit limits.

Chase and Bank of America say they don't comment on individual situations, citing privacy concerns. Bank of America spokeswoman Betty Riess says that generally, "Customers like the fact that their credit line is increased" if the bank considers them a good customer. Chase spokeswoman Tanya Madison says the bank tries to "anticipate our customers' credit needs" by raising limits, but customers can always request less credit.

Pending legislation from Rep. Carolyn Maloney, D-N.Y., and Sen. Chris Dodd, D-Conn., seeks to give consumers more control over their credit limits. The bills would restrict banks' ability to approve charges beyond consumers' card limit and then assess a penalty. But they wouldn't require banks to ask consumers before raising their limits.

When banks extend more credit, younger consumers and the financially inexperienced are more likely to take on debt, a 2002 study by Amar Cheema, of Washington University in St. Louis, and Dilip Soman, of the University of Toronto, found.

Subprime borrowers, many of whom have little experience with credit, tend to use more of their available credit than others do. "Generally, these are consumers who have (greater) need for credit," says Myra Hart, a senior vice president at Equifax.

During the boom, banks focused on getting more plastic into these borrowers' hands: New cards issued to subprime consumers rose 137% from 2003 through 2006, Experian data show.

Banks focused on these consumers because they "don't have five cards already," says David Robertson, publisher of The Nilson Report, an industry newsletter. "They thought they could manage the risk."

Rising delinquencies and defaults suggest otherwise. Overall delinquencies reached 4.9% in the first quarter of 2008, a level not seen since 2002. Card write-offs — which occur when banks give up on recouping the debt — have been rising since the second quarter of 2007.

'Hamster wheel'

Major lenders such as Citibank, Washington Mutual and American Express also sent offers in the mail urging credit card borrowers to use home equity loans to pay off card debt or renovate their homes. One offer in 2006 says: "If you're currently paying more than 13.99% on any personal loan, you should ask yourself, 'Why?' With an American Express Bank home equity credit line, you could easily consolidate those balances to a rate below Prime Rate with no closing costs."

Citibank and Washington Mutual declined to comment. American Express spokeswoman Kim Forde says the offer was sent to "a relatively small population of card members" with strong credit.

Such cross-selling, analysts say, was necessary to keep rivals from luring card customers away with their own offers.

"The deeper the relationship runs, the less likely the consumer will go to another bank," says Lisa Hronek, senior analyst at Mintel Comperemedia, which tracks direct mail and print advertising.

The strategy worked. From mid-2001 through early 2006, consumers extracted a record $538 billion from homes to pay off card and other non-mortgage debt, according to estimates by Federal Reserve economist James Kennedy, based on a paper he wrote with former Fed chairman Alan Greenspan.

In Pevely, Mo., Dan Blanton's credit limits rose from $3,500 to $7,500 during the housing boom. Last year, it jumped an additional $4,000, after he paid off his credit card with a home equity loan.

"I don't plan to run it up," says Blanton, 50. "But I think credit was way too loose" in the past few years.

By raising credit limits to encourage borrowers to pile up more debt and then urging them to pay that debt off with home equity, banks put card customers on a "lucrative hamster wheel," says Joseph Ridout, a spokesman for Consumer Action, an advocacy group.

In theory, paying off high-rate card debt with lower-rate home equity is wise, says Gail Cunningham, a spokeswoman for the National Foundation for Credit Counseling. But the reality, she says, is that many who did so during the boom just "re-debted," running up more card and mortgage debt.

Industry analysts, consumer advocates and lawmakers are starting to fear that some of the $461 billion in card debt that the Fed says was sold as securities to Wall Street investors could unravel, just as a sizable chunk of the $6.5 trillion in mortgage-backed securities is now doing.

"We cannot allow the credit card problem to become the next foreclosure crisis," says Sen. Robert Menendez, D-N.J. Backed by 11 consumer groups and labor unions, he's introduced the Credit Card Reform Act, which would restrict banks' lending practices.

Banks say there's nothing wrong with urging people to shrink their card balances with proceeds from home equity loans. It's up to borrowers, they say, to be responsible.

"It makes sense to be able to consolidate debt at a lower interest rate," says Chessen of the ABA.

But paying off unsecured debt with a loan secured by a principal residence is risky because if you can't pay your bills, you could lose your home, says Ellen Schloemer, director of research at the Center for Responsible Lending.

This strategy could have played a role in foreclosures, says Zandi, of Moody's Economy.com, because homeowners tapped into equity to pay off their credit cards when housing values were high, only to see their equity shrink as prices slid.

With the economy slumping and the job market tightening, more people are getting stuck with debt they can't afford.

"If you have a lot of credit open to you, then if something bad happens, you might jump to use it when it's not the best option," says Lewis-Parks, a publicist for a debt-counseling agency.

Home equity a fading option

Borrowers are turning back to cards because "the spigot has been turned off on home equity lending," says Mark Lauritano of Global Insight, a research firm.

In a recent USA TODAY/Gallup Poll, one in five consumers said they'd been using their credit cards more in the past year. Within this group, 44% are paying for necessities they couldn't otherwise afford. The survey of 845 credit card holders was conducted in late May. Its margin of error is +/- 4 percentage points.

"A lot of the clients we have work in the construction field, and there's not a lot of construction going on," says Diana Navarro, a housing counselor in Sacramento. "They've been using their credit cards for (everyday) expenses."

Credit card limits, after falling in 2006 along with the housing market, began climbing again in mid-2007, according to Equifax data. In the USA TODAY/Gallup Poll, 43% of consumers said the limit on their most-used credit card had risen in the past year. An equal percentage reported no change; 12% either were unsure or didn't answer. Only 2% of consumers reported a decline in their credit limit.

Low-income consumers, who tend to be riskier borrowers, are getting the bulk of the credit-limit reductions, Synergistics Research says. Banks, at the same time, are likely extending more credit to higher-income borrowers, causing an overall increase in average card limits, says McCracken, CEO of Synergistics.

Banks are also raising rates and fees on a growing number of card borrowers — even creditworthy ones — making it more expensive to carry debt. In March, Bank of America as much as tripled card rates for some borrowers — even those who'd paid bills on time and had solid credit, according to USA TODAY's research. And Washington Mutual has told some credit card customers that it's raising their rates by up to 100%, USA TODAY has found.

Both banks say they raise rates as borrowers become riskier.

The danger, says Warren, the Harvard professor, is that the rate hikes could push struggling consumers to default on their bills. These defaults, in turn, could exacerbate the economic downturn, she notes.

Borrowers with adjustable-rate mortgages at least knew the rates would eventually jump, Rep. Maxine Waters, D-Calif., said at a recent hearing. But credit card agreements are "land-mine loans, because it is not at all clear to consumers if, how and when their rates are going to increase," she said.

Marvin Weatherspoon, a supervisor in the Chicago Convention Center's linen department, says a sudden rate increase on his Bank of America credit card last year — from 16% to 25% — has made it nearly impossible to keep up with his other bills. He owes about $12,000 on his credit cards.

"I'm sacrificing all over the place, food, gas and necessities," he says. "It's a real struggle."