CONSUMER LINES OF CREDIT: THE CHOICE BETWEEN CREDIT CARDS AND HELOCS. In the U.S. today consumers have a choice of two major types of lines of credit

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1 CONSUMER LINES OF CREDIT: THE CHOICE BETWEEN CREDIT CARDS AND HELOCS OSU Economcs Workng Paper WP04-04 I. INTRODUCTION In the U.S. today consumers have a choce of two major types of lnes of credt credt cards and Home Equty Lnes of Equty (HELOCs). Over 72 percent of Amercan households have at least one bank-type credt card, and about 15 percent of homeowners have a HELOC, although the rate of growth of HELOCs s currently much greater than that of credt cards. 1 A lne of credt, as opposed to a tradtonal loan, extends a fxed amount of credt to a borrower, and t s then the borrower s decson as to when and how much of that credt to utlze. The lterature on lnes of credt has explored the transactons and precautonary motves and the use of lnes of credt wthn the lfe-cycle hypothess. However, the lterature has not yet addressed the consumer s decsonmakng process nvolved n the choce type of lne to use. There has also been lttle work on the ssue debt-consoldaton, whch s becomng mportant n the market for lnes of credt. Facng a choce between credt cards and HELOCs, a consumer must wegh n the costs and advantages of each. Although HELOCs have the advantage of lower and taxdeductble nterest, ther costs are a dsadvantage. Here we wll show that the choce of type of lne of credt to use depends on the amount the consumer wshes to borrow. Below some threshold level, the costs assocated wth HELOC borrowng outwegh the nterest rate and tax advantages assocated wth ths type of lne of credt. Fnally, gven 1 The Survey of Consumer Fnances, See Azcorbe, et.al. (2003).

2 the fnancal advantages of HELOCs, we address the queston of why a consumer who has ncurred the fxed cost of obtanng a HELOC would chose to borrow on both HELOCs and credt cards a phenomenon whch s observed emprcally. We fnd that n addton to the threshold level of borrowng, there s also an upper bound on HELOC borrowng caused by the rsk of home-loss, and ths lmts the full debt-consoldaton that one would otherwse ratonally expect. We wll use data from the Survey of Consumer Fnances 1995, 1998 n the emprcal nvestgaton of these ssues. We wll estmate the decson to borrow on a HELOC and ts effect on credt card debt usng an endogenous swtchng regresson model. After dscussng the background and prevous research n ths area n the next secton, we ntroduce the theoretcal model n Secton III. The data and emprcal model are presented n Secton IV. Sectons V and VI dscuss emprcal results and present our conclusons. II. PREVIOUS RESEARCH AND BACKGROUND Among the earlest work on credt cards was that done by Ausubel (1991), who argued that some consumers borrow on hgh-rate credt cards because they underestmate ther lkelhood of carryng a balance. Brto and Hartley (1995) responded to ths by argung that consumers borrowed on hgh-rate credt cards because alternatve consumer loans nvolved transactons costs. Mester (1994) further argued that low-rsk borrowers left the credt card market n favor of low-nterest collateralzed loans, thereby makng the credt card clent pool rsker and preventng nterest rates from fallng. Park (1997) explaned credt card nterest rate stckness usng the opton value nature of lnes of 2

3 credt. An emprcal paper by Calem and Mester (1995) found evdence for consumers reluctance to search for lower rates due to hgh search costs n ths market. A subsequent paper by Cargll and Wendel (1996) suggests that due to the hgh presence of convenence users, even modest search costs could keep the majorty of consumers from seekng out lower nterest rates. Gross and Souleles (2002) utlze a unque new dataset on credt card accounts to analyze how people respond to changes n credt supply. They fnd that ncreases n credt lmts generate an mmedate and sgnfcant rse n debt, consstent wth the buffer-stock models of precautonary savng, as cted n Deaton (1991), Carroll (1992), and Ludvgson (1999). General features of the HELOC market have been documented by DeMong and Lndgren (1990); Canner and Luckett (1994); Canner, Durkn, and Luckett (1998); and Azcorbe, Kennckell, and Moore (2003). Eugen (1993) examned the tax and nterest advantages of HELOCs. Motvatons for HELOC use have been nvestgated by Chen and Jensen (1985), who analyzed HELOCs n the framework of the lfe cycle hypothess of consumpton; Delaney (1994), who explaned HELOC use as a way to tap nto the forced savngs ncorporated n mortgage payments; and Salandro and Harrson (1997), who emprcally determned the demand for HELOCs as a functon of fnancal and socoeconomc characterstcs. 3

4 III. THE THEORETICAL MODEL Below we defne the varables used n ths paper: Defntons of Varables W Wealth of the consumer t Income tax rate; 0 < t < 1 C Cost of collateralzaton δ Dscount factor; 0 < δ < 1 D C Debt on credt card α Requred rate of repayment; 0 < α < 1 D H Debt on HELOC τ Fxed cost of HELOC; τ > 0 r C Credt card nterest rate r H HELOC nterest rate The nsttutonal background of the market for lnes of credt wth whch we wll be dealng s realstcally assumed to have the followng characterstcs. The nterest rate on credt cards r C s greater than the nterest rate on HELOCs r H. 2 The requred rate of repayment (α) s the same for HELOCs and credt cards. (The usual rate of repayment s 2-5 percent per month of outstandng balances on both types of credt lnes.) We wll be dealng wth consumers who actually pay back at the requred rate. The cost of collateralzaton of credt (C), whch arses from the rsk of losng one s home, wll be taken to be a postve functon of the debt carred on HELOC, or C = c(d H ), 1 > c > 0. III.a THE CHOICE BETWEEN CREDIT CARDS AND HELOCS Now we address the ssue of choce of lnes of credt when the consumer has both credt cards and HELOCs avalable. The consumer s faced wth two decsons: (1) should the low-nterest but otherwse costly HELOC actually be acqured; and (2) f a HELOC s acqured n addton to a credt card, how much debt should be put on each. 2 Ths s usually the case except for ntroductory credt card offers, whch are excluded from ths analyss. 4

5 Let the dscounted expected lfetme utlty from not acqurng a HELOC and potentally carryng a debt of amount D on a credt card (the unsecured lne of credt) be gven by V C = V C (W, r C, δ, α, D). Let the dscounted expected lfetme utlty from potentally borrowng the amount D only on a HELOC (the secured lne wth tax-deductble nterest payments) be gven by V H = V H (W, r H, δ, α, t, τ, c, D). Hence, τ > 0 and for D = 0, we have V H V C < 0. In other words, gven postve fxed costs for HELOCs, the consumer wll never consder borrowng on a HELOC unless he/she antcpates ncurrng a postve amount of debt. We draw now upon the followng condton, whch realstcally represents the stuaton for a consumer wth access to both types of lnes of credt. Condton 1: V H V C s a strctly ncreasng functon of D. Hence HELOC borrowng becomes more attractve for the consumer as the desred debt rses due to the effect of the lower, tax-deductble nterest rates assocated wth HELOCs. If the consumer has actually acqured both a credt card and a HELOC, then the ssue of debt-consoldaton should be consdered. The new dscounted expected lfetme utlty from potentally borrowng D when both types of lnes of credt have been acqured s V B = V B (W, r C, r H, δ, α, t, τ, c, D C, D H ) where D C s the credt card debt, D H s the HELOC debt and D C + D H = D. Ths stuaton presents the consumer wth a tradeoff namely, the advantages of the low-nterest and tax-deductble HELOC must be weghed aganst the ncreasng rsk 5

6 of home-loss as the amount of HELOC borrowng ncreases. We now use the followng condton: Condton 2: V D B B ( ) ( ) H V D C s a strctly decreasng functon of D H that ntersects the D H -axs at D (> D ). Hence at some pont, the benefts of consoldatng debt nto HELOCs are outweghed by the dsadvantage of the rsng rsk of home-loss. From the foregong analyss of consumer s choce, and gven our assumptons about the nsttutonal structure of the consumer lnes of credt market along wth Condtons 1 and 2, we have the followng results:. D > 0, such that V H V C = 0,. For D < D, we have V H V C < 0,. For D > D, we have V H V C > 0 and v. For D > D > D, we have V B > C H D = D D, D = D V H. These results can be summarzed as follows. The costs assocated wth a HELOC prevent the consumer from usng a HELOC for small amounts of desred debt,.e., where D < D. It only makes sense for a consumer to borrow on a HELOC f the desred debt level exceeds D. For a consumer wth both credt cards and HELOCs at hs/her dsposal and wth desred debt below a certan level (.e. D D ), transferrng balances transfer away from hgh-nterest credt cards and nto HELOCs s benefcal. Fnally, for an extremely large desred debt level (.e. for D > D > D ), the cost of collateralzaton arsng from the rsk of home-loss wll be great enough that further debt-consoldaton nto HELOCs makes the consumer worse off. In these stuatons we fnd consumers 6

7 nduced to carry debt on both credt cards and HELOCs. In the next secton, we wll emprcally dentfy D and estmate the extent to whch debt-consoldaton nto HELOCs has mpacted the credt card market. IV. THE DATA AND THE ECONOMETRIC MODEL We use a pooled sample of the 1995 and 1998 rounds of the U.S. Survey of Consumer Fnances (SCF). 3 Of these, 5,157 households had a postve equty n ther homes and held at least one bank-type credt card, and ths group consttuted our fnal sample. Approxmately 36 percent of households n our sample carred a postve credt card balance. HELOC holders represented approxmately 12 percent of the sample, and 55 percent of these had actually borrowed on ther HELOCs. The nterest rate varables used here are the rate on the credt card wth the largest balance 4 and the actual loan rate on HELOCs. Table 1 below presents the mean amounts of borrowng and the mean nterest rates for the sample of credt card and HELOC borrowers. Table 1: Descrptve Statstcs for Credt Card and HELOC Borrowers Varable Mean Debt (S.D.) Credt Card 4,558 (8,259) HELOC 46,075 (14,8690) Mean Interest Rate (S.D.) 13.9 (4.7) 9.5 (2.2) 3 All varables were converted to 1998 dollars. 4 For those households who dd not carry a balance, the rate s the one for the most recently acqured card. 7

8 The Econometrc Model Usng the consumer s dscounted expected lfetme utlty from potentally carryng amount of credt card debt, we have the optmal credt card debt for household as D C* = g (W, r C, α, δ ). Smlarly, the optmal HELOC debt for household s D H* = h (W, τ, c, t, r H, α, δ ). At D = D, we have V H V C = 0; therefore the cutoff or threshold debt level D whch moves a consumer to a HELOC s a functon of all the varables of the model. Hence for household, the threshold level of debt s gven by D = f (W, τ, c, t, r H, r C, α, δ ). C* D Testable Implcatons from the Theoretcal Model Wthn the framework presented above, we can now move to the followng testable mplcatons. Implcaton 1: HELOC debt for household (D H* ) s observed only f t s greater than the threshold level of debt D. Implcaton 2: For household, the margnal gan from consoldatng debt away from credt cards and nto HELOCs s non-negatve for all combned debt levels less than D, or B C* H* B C* H* [ V ( D, D )] [ V ( D, D )] H* C* 0, & 0 D H C + D * * D D D. The motve to consoldate debt nto HELOCs s lkely to make the observed sample of credt card debt non-random. Gven testable mplcaton 2, we expect the observed credt card debt to be negatvely nfluenced by HELOC ndebtedness. The observatonal dvson of credt card debtors nto those wth and those wthout HELOC debt must be 8

9 H* captured by two dfferent credt card debt equatons. The endogenous varable D should defne whch of the two credt card debt equatons s relevant for household. The debt-consoldaton motve therefore brngs n smultanety n the consumer s choce of debt. We wll account for ths smultanety n our econometrc model wth a two-stage probt analyss. Moreover, followng testable mplcaton 1, we expect the household to decde to borrow on HELOCs f the desred HELOC debt D H* s greater than the threshold level D. Hence, our econometrc model has to ncorporate ths selecton process nto the estmaton as well. Counterparts from the Data We wll use the followng emprcal quanttes to represent the varables of the model: Wealth Factors W : equty n the home, lqud assets, other non-fnancal assets, and household sze. Credt Card Factors X 1 : W, credt card nterest rate, the repayment rate α, credt card borrowng lmt, and the vector S whch ncludes age, ncome, ethncty, household sze, and educaton level. Rsk Factors R : a dummy varable based on the ncdence of delnquency, dummes capturng household s atttude towards rsk, and the repayment rate α Tax Factors T : a vector ncludng a dummy varable whch determnes whether household temzes tax-deductons or not, and household ncome Mortgage Factors M : a vector ncludng ncdence of mortgage debt, debt repayment frequency, and mortgage rate of nterest Dscount Factors S : a vector ncludng age, ncome, ethncty, household sze, and educaton level We capture the household s dscount factor δ and the ncome tax rate t by the followng equatons: 9

10 δ = ϕ S + η and t = a 2 + a 3 T + e 2. Assumng neglgble costs of obtanng credt cards, we have wthn our sample the observed credt card debt D C to be equal to the desred credt card debt D C*. Among the C HELOC debtors, we have the followng equaton for credt card debt D D C = γd H + β 1 X 1 + u 1 (1) where D H s the observed HELOC debt and X 1 s a vector of exogenous varables affectng credt card debt D C as defned above. Smlarly, among the HELOC nondebtors, we have another equaton for credt card debt D C = β 3 X 1 + u 3 (2) The margnal cost of collateralzaton of credt, c, s consdered to be a functon of the ndvdual s rsk-type. The fxed costs of obtanng HELOCs (τ ) have no varaton across households,.e. we have τ = τ. Therefore, the fxed costs are represented by the constant terms of the HELOC and threshold debt equatons. Moreover, equty n the home (HOMEQUITY), the rsk-type (captured by vector R ), and mortgage factors M descrbe the HELOC nterest rate r H. Thus we have c = a 0 + a 1 R + e 1 and r H = a 4 + a 5 HOMEQUITY + a 6 R + a 7 M + e 3. Substtutng for c, t, τ, δ and r H nto D H*, and usng W and α, we have a reduced form H* equaton for the HELOC debt D D H* = β 2 X 2 + u 2 (3) where X 2 s a vector of exogenous varables nfluencng D H*. 10

11 Wth smlar substtutons we have another reduced form equaton for the reservaton or threshold level of debt D D = β 4 X 4 + u 4 (4) where X 4 s a vector of all the exogenous varables n our model. We observe HELOC debt f D H* > HELOC debt to be I * = D H* - D = β 2 X 2 - β 4 X 4 + u 2 - u 4 D. Therefore we defne the choce functon for = δ Z - u. (5) Hence our econometrc model s gven by D D C H = γd = D H H * ' + β X 1 1 ' = β X u 1 + u 2 f I * >0 D D H C = 0 ' = β X u 3 otherwse where u 1, u 2, u 3 and u follow multvarate normal wth zero means, varances σ 1 2, σ 2 2, σ 3 2 and 1, and correlaton coeffcents ρ 12, ρ 13, ρ 1u, ρ 23, ρ 2u and ρ 3u respectvely. If X 2 contans at least one varable that s not ncluded n X 1, then all the parameters of the model are dentfed. Snce HELOC s a secured lne of credt and t has unque features such as nterest tax-deductblty, the varables capturng these propertes, such as c and t, provde the necessary varables for dentfyng the parameters of our model. Hence, n order to correct for the endogenety present n the credt card debt equaton of HELOC H borrowers, we use the estmated HELOC debt Dˆ as an nstrument. 11

12 The above econometrc model s estmated by two-stage probt method. Lee et al. (1980) descrbe the estmaton procedure. In our model, I * s not observed. All we observe s I = 1 f household carres HELOC debt (.e. f I * > 0) = 0 otherwse. Let us assume that there are N 1 observatons for whch I = 1 and N 2 observatons for whch I = 0, so that the total sample sze s N = N 1 + N 2. We then defne φ = φ(δ Z ) and Φ = Φ(δ Z ), where = 1, 2..N; φ s the standard normal densty and Φ s the cumulatve normal. Snce E(u 2 I = 1) = - σ 2u φ, Φ we can wrte equaton (3) for the HELOC debtors as D H = β 2 X 2 - σ 2u φ Φ + µ 2 where E(µ 2 ) = 0 and σ 2u = Cov(u 2, u). We frst estmate δ by probt maxmum lkelhood (.e. we get δˆ ). Then we estmate D H = β 2 X 2 - σ 2u ˆ φ + µ 2 Φˆ by ordnary least squares. Here and Φˆ are φ and Φ wth δˆ substtuted for δ. φˆ We smlarly estmate the reduced form parameters n equaton (2). We have 12

13 ˆ D C = β φ 3 X 1 + σ 3u + µ 3 1 Φˆ where σ 3u = Cov(u 3, u). The structural equaton correspondng to I = 1 s gven by D C = γd H + β 1 X 1 + u 1. Snce E(u 1 I = 1) = - σ 1u φ, Φ we can wrte equaton (1) as D C = γd H + β 1 X 1 - σ 1u φ Φ + µ 1 where E(µ 1 ) = 0 and σ 1u = Cov(u 1, u). We estmate D C H = γdˆ + β1 X 1 - σ 1u φˆ Φˆ + µ 1 ˆ H φ by ordnary least squares, where Dˆ = ˆβ 2 X2 - ˆ σ 2 u. Φˆ Snce all the second stage estmatons use estmated varables as regressors, the asymptotc covarance matrces of the second stage ordnary least squares estmators requre correctons. See Lee et al. (1980) for the dervatons of the asymptotc covarance matrces of two-stage probt estmators. 13

14 V. EMPIRICAL RESULTS AND DISCUSSION The defntons of varables used n the emprcal analyss are found n Table 2 below. We next move to the results of the estmaton of the probt equaton explanng the household s decson to carry HELOC debt, whch are presented n Table 3. We fnd that HELOC debt-holdng ncreases wth the amount of equty n the home and wth household sze. Household ncome and other types of assets have a negatve mpact on the HELOC debt-holdng decson. The effect of delnquency s negatve, thus provdng some support for Mester s (1994) hypothess that relatvely low-default-rsk borrowers self-select themselves as HELOC debtors. However, the predcted sgn for hgh rsktakng households s postve and the sgn for households who take no rsks s negatve, whch ndcates that HELOC borrowng becomes less attractve as borrowers become more rsk-averse. The estmated sgns of varables related to credt cards, mortgages, and socoeconomc characterstcs are as expected. Table 4 presents the two-stage probt results explanng the level of HELOC debt. The varables capturng household wealth have a sgnfcant postve mpact on the volume of HELOC debt. Among the set of HELOC debtors, the hgh rsk-takng households are found to carry more debt. As before, ncome has a negatve mpact. Snce the estmated coeffcent of LAMBDA, gven by -σ 2u, s not sgnfcant, there s no emprcal evdence of sample selecton n the estmates of the HELOC debt equaton. Even though mplcaton 1 above postulated the exstence of a lower bound D for HELOC borrowng, correctng for ths possble selecton bas does not emprcally mprove the predctve power of our varables. 14

15 Table 2: Defntons of Varables Varables HELOCDEBT HELOCRATE HOMEQUITY LIQUIDASSETS OTHERASSETS TAX DELINQUENCY CREDITCARDDEBT CREDITCARDRATE CREDITLIMIT INCOME REPAYMENTRATE MORTGAGE HIGH-RISKTAKER c AVERAGE-RISKTAKER NOT-RISKTAKER MORTGAGERATE AGE EUCATION ETHNICITY HOUSEHOLDSIZE REPAYMENTFREQ e Explanaton HELOC debt HELOC rate of nterest a Equty n home Lqud assets Other non-fnancal assets 1 Itemze ncome tax deductons 0 Otherwse 1 Behnd n payments by two months or more 0 Otherwse Credt Card Debt Credt Card Rate of nterest Credt Card Borrowng lmt Income The requred rate of repayment b 1 Household has some knd of mortgage debt 0 Otherwse 1 Above average rsk-taker 0 Otherwse 1 Average rsk-taker 0 Otherwse 1 Not a rsk-taker 0 Otherwse Mortgage rate of nterest d Age of the household head Years of schoolng of the household head 1 Non-whte 0 Otherwse Sze of household 0 No or flexble repayment requred 1 Less frequent than monthly repayment requred 2 Monthly repayment requred 3 More frequent than monthly repayment requred a Maxmum nterest rate charged among the dfferent HELOCs taken out by the household. b Fracton of HELOC and mortgage debt repad. c Household s rsk-tolerance on a 1 to 4 scale. d Maxmum nterest rate charged among the dfferent mortgage loans taken out by the household. e Maxmum of the repayment frequency on HELOC and mortgage debt. 15

16 Table 3: Probt Equaton Explanng the Decson to Carry HELOC Debt Varable Coeffcent S.E. CONSTANT -3.81*** 0.34 HOMEQUITY LIQUIDASSETS * OTHERASSETS HIGH-RISKTAKER NOT-RISKTAKER -0.21** 0.1 DELINQUENCY INCOME ** TAX REPAYMENTRATE MORTGAGE -2.38*** 0.26 MORTGAGERATE REPAYMENTFREQ 1.75*** 0.1 CREDITCARDRATE -0.01* 0.01 CREDITLIMIT 0.001** AGE 0.01*** EDUCATION 0.05*** 0.02 ETHNICITY HOUSEHOLDSIZE 0.1*** 0.02 *** Sgnfcant at 1% Level; ** Sgnfcant at 5% Level; * Sgnfcant at 10% Level. The two-stage probt results for the credt card debt equaton for households who also have HELOC debt are presented n Table 5. Here we also fnd no evdence of sample selecton bas, but there s evdence of smultanety n these results. Hence the volume of HELOC debt has had a sgnfcantly negatve nfluence on the household s credt card borrowng. Ths s emprcal evdence n support of the mplcaton 2, whch lays out the condtons under whch a consumer should optmally consoldate credt card debt nto a HELOC. Table 6 below presents the two-stage probt estmates of the credt card debt equaton for households wth no HELOC debt. The wealth varables n general show weak or no relatonshp to credt card borrowng for ths group. The credt card varables of nterest,.e., credt lmt and nterest rate, have the expected sgns but low levels of 16

17 Table 4: Two-Stage Probt Estmates Table 5: Two-Stage Probt Estmates of of HELOC Debt Credt Card Debt for HELOC Debtors Varable Coeffcent S.E Varable Coeffcent S.E CONSTANT CONSTANT HOMEQUITY 0.05*** 0.01 HOMEQUITY LIQUIDASSETS 0.09* 0.05 LIQUIDASSETS 0.007* OTHERASSETS 0.01*** OTHERASSETS * HIGH-RISKTAKER 22.59* NOT-RISKTAKER DELINQUENCY INCOME -0.07*** 0.02 INCOME ** TAX REPAYMENTRATE REPAYMENTRATE MORTGAGE MORTGAGERATE REPAYMENTFREQ AGE AGE EDUCATION EDUCATION ETHNICITY ETHNICITY 2.78* 1.66 HOUSEHOLDSIZE HOUSEHOLDSIZE 0.94** 0.46 CREDITCARDRATE CREDITLIMIT 0.08*** 0.02 HELOCDEBT -0.05* 0.03 LAMBDA LAMBDA R 2 = 0.39; F-value = *** ; σ 2 = 113.1; N = Log L = ; σ 1 = 9.18; N = 346. ˆ φ *** Sgnfcant at 1% Level; ** Sgnfcant at 5% Level; * Sgnfcant at 10% Level; LAMBDA =. Φˆ 18

18 Table 6: Two-Stage Probt Estmates of Credt Card Debt for Non-HELOC Holders Varable Coeffcent S.E. CONSTANT 2.76*** 0.7 HOMEQUITY LIQUIDASSETS * OTHERASSETS REPAYMENTRATE INCOME CREDITCARDRATE CREDITLIMIT * AGE -0.03*** EDUCATION ETHNICITY HOUSEHOLDSIZE LAMBDA -4.88*** 0.78 φˆ R 2 = 0.03; F-value =12.2 *** ; σ 3 = 5.46; N = 4,811; LAMBDA = 1 Φ. *** Sgnfcant at 1% Level; ** Sgnfcant at 5% Level; * Sgnfcant at 10% Level. sgnfcance. The key result from ths ft comes from the coeffcent of LAMBDA, whch s negatve and sgnfcant. Ths ndcates that households wth no HELOC debt also tend to have a lower average credt card debt, and hence s emprcal evdence of sample selecton n the estmates of ths credt card debt equaton. Ths has essentally dentfed a low-debt group, and the only socoeconomc varable strongly assocated wth ths phenomenon s ncreasng age. Usng the probt and two-stage probt estmates for HELOC debt, we can derve a consstent estmate of the threshold or reservaton debt level for each household beyond whch t would be observed to carry HELOC debt. Thus for example, for the medan household n the sample wth an ncome of $81,000, the threshold level of debt whch would nduce t to turn to HELOC borrowng would be $64,000. We fnd, ceters parbus, that HELOC borrowng becomes more attractve as ncome ncreases. 19

19 VI. Summary and Conclusons Ths paper has addressed the consumer s choce of debt nstrument n the market for lnes of credt where both credt cards and HELOCs are avalable. Gven the costs and advantages of the dfferent lnes of credt, we derve condtons showng that the choce between credt cards and HELOCs depends on the amount of borrowng that consumers wsh to undertake. For small borrowng needs, our theoretcal model shows that consumers wll use credt cards exclusvely; and for relatvely large borrowng needs, they wll use only HELOCs. Ths ncludes those who replace ther credt card debt by fully consoldatng nto a HELOC. However, when the desred amount of borrowng reaches a certan level, consumers wll be constraned by the mountng rsk of home-loss and wll use both type of lnes of credt for borrowng purposes. We have derved the theoretcal condton that puts a cap on HELOC borrowng and hence on full debtconsoldaton nto HELOCs. Thus we fnd a ratonal explanaton for the observed phenomenon of consumers carryng debt on both HELOCs and credt cards. Usng SCF data, we have estmated the consumer s decson to hold HELOC debt and the emprcal threshold level of desred debt that nduces ths decson. We use an endogenous swtchng regresson model to determne the factors nfluencng credt card debt, n partcular the nfluence of the endogenous varable HELOC debt, usng a twostage probt method. The emprcal analyss supports our theoretcal framework. We fnd that HELOC debt depresses credt card debt. We precsely dentfy the threshold levels of desred debt whch wll swtch a consumer wth gven fnancal and socoeconomc characterstcs nto the HELOC market. 20

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