Why Banks Have Been Extending More Credit Even as They Clamp Down

While credit scores have been dropping, even for consumers with perfect payment histories, and banks are refusing to lend based on those lower credit scores, the amount of money being lent still increased in 2008.

How can that be?

Both consumers and businesses have been tapping into sources the banks did not expect them to use: previously issued lines of credit.

Commercial borrowers that financed themselves through securities markets had purchased and paid for back up lines of credit. Now, unable to get the financing they need for expansion, they're using those lines.

Many homeowners have similar lines - some of which were established when their homes were purchased. These lines, known as Home Equity Lines of Credit, or HELOC's, were often used to make up a deficiency in down payment amounts - allowing the borrower to obtain first mortgages at 80% of the home's value, thus sparing them from expensive mortgage insurance.

Lenders advised them to apply for the maximum allowable - just in case they needed it at a later date.

Other homeowners, in need of remodeling or repair money, obtained HELOC's at a later date. For many it made more sense financially than a "cash out" refinance of their home.

Again, lenders recommended obtaining the line for the maximum allowable - just to have the funds immediately available in the future without needing to go through the paperwork or pay for new appraisals, loan fees, etc.

As the balances were paid down, the amount available for future access increased. Little did those lenders realize the value of their advice - because these loans might not be available just a few short years later.

Now, as small home-based businesses run into brick walls when trying to borrow for needed equipment, they're turning to the equity in their homes to keep their businesses running.

The down side, of course, is that most HELOC's were based on an adjustable rate mortgage, so interest rates can be high. But for a small business person with no other choices, they are a lifeline. After all, if you run a catering business and the engine in your delivery van blows up, you're out of business until it's repaired.

Consumers have also been tapping into credit card cash limits for both business and personal emergencies - but credit card issuers have been quick to reduce those limits - effectively cutting off emergency funding even for their best customers.

Consumers across the nation are tightening belts and learning to differentiate between "want" and "need," and all know that it's good accounting practice to keep business and personal expenses separate. But when your livelihood depends on mixing the two, most consumers will mix.