Are storm clouds gathering for borrowers who took out home-equity lines of credit, or HELOCs?
According to mortgage and credit experts, billions of dollars of home-equity credit lines extended to borrowers a decade ago during the housing boom could be headed for trouble soon, creating a new wave of defaults. Loan performance data from Equifax, one of the three national credit bureaus, shows delinquencies rise for borrowers who face increases in monthly payments.
During the go-go days of the housing boom, homeowners across the country took out home-equity lines of credit, as their properties gained value. When the housing market tanked in 2008, the HELOC market dried up and bankers tightened up lending standards as home prices plummeted.
So why will HELOC resets cause problems?
HELOCs are considered open-ended loans, and come with an interest-only payment option, but only until the end of the draw period — a period of 10 years or so during which the borrower can make withdrawals up to their credit limit. However, when the draw period stops, the game is over — withdrawals end and the HELOC becomes fully amortized and monthly payments increase sharply. For example, a borrower might get 20 years to repay a HELOC with a 10-year draw period.
“The year 2013 will see the first waves of end-of-draw transitions, when borrowers no longer have access to credit lines and monthly payments increase due to amortization,” according an Office of the Comptroller of the Currency report. “Declining home values and tightened underwriting standards will exclude some borrowers from market-based refinancing into new draw periods, and the higher scheduled payments will put upward pressure on delinquency levels.”
Translation: HELOC defaults could rise in the coming months.
Some 817,000 homeowners, with $23 billion in loans, will see their interest-only jump upwards this year, according to Equifax. Next year, an average of $53 billion in HELOCs will reset to higher rates. And HELOCs will peak at $73 billion in 2017.
“The most critical part of the HELOC reset situation is assessing a consumer’s ability to repay the loan,” says Rosie Biundo, senior product marketing director, Equifax, a firm that tracks consumer-lending trends.
Financial regulators, including the Comptroller of the Currency, are aware of the potential wave of defaults and have been urging the biggest banks to set aside extra reserves for possible future losses. The HELOC reset problem is expected to be especially large in Arizona, California, Florida and Nevada, which had the largest surge in home prices and borrowing 10 years ago.
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