As much as 20 percent of home equity lines of credit worth $79 billion are at increased risk of default as their payments jump a decade after the loans were made during the U.S. housing boom, according to TransUnion Corp.
Borrowers face rate shocks as payments on the credit lines, known as HELOCs, switch from interest-only to include principal, causing monthly bills to surge more than 50 percent, according to a report today by the Chicago-based credit information company. The 20 percent of borrowers most in danger of default are property owners with low credit scores, high debt-to-income ratios and limited home equity, said Ezra Becker, TransUnion’s vice president of research.
Maturing home equity lines, which allow borrowers to use the value of their home as collateral on loans for personal spending, are the last wave of resetting debt from the era of high property values and easy credit before the 2008 financial crisis. The three biggest home equity lenders -- Bank of America Corp., Wells Fargo & Co., JPMorgan Chase & Co. -- held 36 percent of the $691.5 billion debt as of the first quarter, according to Federal Reserve data.
“It’s nothing trivial for the consumers who end up in default or the banks that potentially have large portfolio concentrations,” Mark Fleming, chief economist for CoreLogic Inc., said in an e-mail. “But an impactful risk to the mortgage finance system or our housing market, that’s harder to see.”
About $23 billion in HELOCs will have payment increases this year as the interest-only phase ends, rising to a projected peak of $56 billion in 2017, according to a June report by the Treasury Department’s Office of the Comptroller of the Currency. Most debtors can refinance or absorb the payment increases, with the number of borrowers at risk declining as unemployment falls and home values rise, Becker said.
Applications for unemployment benefits fell to an eight-year low over the past four weeks, a sign the U.S. job market continues to gain momentum, a Labor Department report from Washington showed today.
Many borrowers either forgot or never knew their home equity lines would reset, making it important for banks to send out early alerts that the clock is ticking, TransUnion’s Becker said. At the “end-of-draw period,” which is usually 10 years after the loans started, they can no longer tap the credit line to raise cash and must begin repaying the principal and interest.
The higher monthly payments can be harsh for people on stretched budgets. In the case of an $80,000 HELOC with a 7 percent interest rate, monthly payments jump from $467 to $719 when the principal is included, a 54 percent increase. More than half of the outstanding HELOCs have a balance above $100,000, Becker said.
“Once lenders can identify who’s at high risk, they can intervene and try to mitigate the problem,” he said. “So while we say up to $79 billion may be at elevated risk, we think that with prudent action by lenders it can be less.”
Bank of America, which had $89.7 billion in outstanding home equity loans as of June 30, the most of any bank, begins reaching out to borrowers more than a year before the reset date to help them prepare for the higher payments, according to Matt Potere, home equity products executive at the Charlotte, North Carolina-based bank.
“If a customer does have a hardship that would impact their ability to repay the principal on their loan, we have several programs to assist them based on their individual circumstances,” Potere said in an e-mail. Those programs include loan modifications which could entail principal reduction, he said.
About 76 percent of Bank of America’s HELOCs have yet to end the interest-only period, according to a July 29 filing. The 30-day delinquency rate was about 3 percent on loans after the reset period compared with a 1 percent rate for loans in the interest-only phase.
Borrowers who received notices from Wells Fargo, which had $80 billion of home equity loans as of June 30, often were “deathly frightened and didn’t understand” when they were told about the payment change, said Pamela Simmons, a mortgage and tax attorney, who represents struggling borrowers, including many immigrants, in Santa Cruz County south of San Francisco.
“They think something bad’s going to happen to them right away,” Simmons said in a phone interview from her office in Soquel, California.
One of her clients who responded to a notice was able to refinance a Wells Fargo HELOC, which was “a good outcome,” she said.
Other cases are more complicated. Maritza Alfaro Escobar, who became Simmons’ client last month, said Wells Fargo told her that she had to pay the entire $64,000 balance on her loan when the interest-only period ended in December. Alfaro Escobar, a self-employed house cleaner, said she didn’t have the money and Wells Fargo wouldn’t offer her new financing on the loan, which was originally written by a correspondent lender.
“The bank wouldn’t help me,” Alfaro Escobar, 45, said. “They said I didn’t make enough money.”
Wells Fargo has $23.4 billion in home-equity loans scheduled to end the interest-only phase in 2015 through 2017, including some that “have been structured with a balloon payment, which requires full repayment of the outstanding balance at the end of the term period,” according to a company filing.
The bank can’t comment on this specific case, “but we have potential options for distressed customers including payment modification or a restructuring of the loan that could make repayment more manageable,” Vickee Adams, a Wells Fargo spokeswoman, said in an e-mail.
Banks slashed home equity lending and pulled unused lines after 2007, when originations reached a record high of $80 billion, according to TransUnion. New issuance plunged to a post-housing crash low of $17.8 billion in 2010 and rebounded to $27.9 billion last year as lenders began reopening the spigot after home values started to recover. Demand for HELOCs rose last month for the first time since October, according to a Federal Reserve senior loan officer opinion survey.
Banks wrote down 1.2 percent of HELOC debt as uncollectible last year compared with a high of 3.2 percent in 2009, the Office of the Comptroller of the Currency report said.
Unlike first-lien mortgages, which are packaged and sold as bonds, most HELOC debt remains on bank balance sheets, representing about 7 percent of outstanding consumer loans at national banks as of Dec. 31, according to the OCC.
Because the loans aren’t sold to investors, banks have more flexibility to ease terms for HELOC borrowers, according to Ira Rheingold, executive director of the National Association of Consumer Advocates in Washington. The banks also have little incentive to foreclose or force a short sale for a loss, because second liens are wiped out before first mortgages and they can end up with nothing, he said.
Alfaro Escobar and her husband, Oswaldo Menjivar, a carpenter, continue to pay the first mortgage on the home they bought for $385,000 in 2002 with a $308,000 first mortgage from America’s Wholesale Lender, which was later acquired by Bank of America. The three-bedroom house is now worth $202,000, according to Zillow Inc., a sale price that would leave nothing to recover for Wells Fargo on the second loan.
Settlements between banks and regulators often require lenders to forgive debt or modify mortgages, which borrowers can use to their advantage to strike deals, Rheingold said.
The five largest U.S. mortgage lenders -- Bank of America, Wells Fargo, JPMorgan Chase, Citigroup Inc. and Residential Capital LLC, a unit of Ally Financial Inc. -- provided $20.7 billion in loan modifications and debt forgiveness on first- and second-mortgages under a 2012 settlement with state and U.S. attorneys generals, according to an April report by Laurie Goodman, director of the Housing Finance Policy Center at the Urban Institute in Washington. Bank of America provided $2.2 billion or 23 percent of its relief to borrowers through second-lien modifications, the report said.
Total home equity debt, including second liens and reverse mortgages, peaked at $1.13 trillion in 2007 and declined to $691.5 billion in the first quarter, according to Federal Reserve data. About $474 billion of home equity lines were outstanding at the end of last year compared with $8 trillion in first-lien mortgages and $1.1 trillion in student loans, according to TransUnion.
That implies resetting HELOCs won’t pose a big threat to the larger economy, TransUnion’s Becker said.
“We estimate about $50 billion to $79 billion is at elevated risk,” Becker said. “It’s a big number, yes. But it’s not the entire marketplace.”