The foreclosure numbers look so much better these days that at first glance it’s hard to see any big national problems looming ahead. After all, as RealtyTrac points out, July foreclosure levels were 16 percent below a year earlier.
But look closer and at least three major trends could scuttle the emerging real estate recovery: HELOCs, HAMP resets and a divided economy. Until we get past these hurdles the real estate market will remain fragile and frail.
As of December 2013, some 16 million U.S. consumers held $474 billion in home equity lines of credit — HELOCs — debt that is outstanding today, according to TransUnion. Such loans are typically second liens, essentially giant credit cards which can be used as a financial tool to get cash from a home without selling it. Unlike credit cards, however, HELOC interest is generally much lower because the debt is secured by real estate and whatever the HELOC rate, it’s generally deductible.
All of this sounds pretty good until you realize that the best time for HELOCs was 2007. That year more than $80 billion in HELOC financing was originated. As it happens 2007 was also the last gasp of the anything-goes mortgage era, the very moment just before the fall.
What happened next is that many HELOCs went into a sort of hibernation mode. Lenders cut off the ability of borrowers to take more money from HELOC accounts while at the same time monthly payments could be sustained because interest-only payments were allowed. Superficially all seemed well in the HELOC marketplace because payments were being made while HELOC loans — by-and-large — were not being foreclosed.
Now this comfy-and-convenient arrangement is coming to an end. According to TransUnion, HELOCs worth $79 billion are coming due in the next few years and for several million borrowers such payments will be unaffordable.
To understand why let’s look at how HELOCs are organized. First there’s a “draw” period of five to 10 years when borrowers are allowed to take money from their home equity lines of credit and then a “pay-down” period of perhaps five years during which time withdrawals are not allowed and the balance must be repaid.
In practice here’s how this works:
Imagine that the Smiths have $100,000 in HELOC debt. During the draw period they make required payments as if the loan was an interest-only debt. If the interest rate is 6 percent then the monthly payment is $500.
In the pay-down period things are different. There is a $100,000 debt which must be paid off over five years. If the interest rate is 6 percent then the monthly payment for principal and interest will amount to $1,933, a crushing burden for many households.
The solution? Modify the loan and extend the debt for 30 years. At 6 percent over 30 years the monthly payment for the loan will be $600 — a much-more tolerable amount. On the books lenders will have performing loans while both borrowers and lenders can avoid a foreclosure.
The problem? Many borrowers will be unable to sell until they have enough equity to cover the loan, something that might take decades in some areas. The result will be fewer home sales and — conversely — with less inventory for sale home prices will likely be pushed up with greater speed than would be the case with a flood of foreclosures.
Back in 2009 the government started the “Making Home Affordable Program,” or HAMP, in an effort to refinance homes facing foreclosure. The program has several parts and the most important is HAMP, the “Home Affordable Modification Program.” With HAMP, borrowers who run into financial troubles and have a loan which was originated prior to 2009 can get some help.
The “help” is in the form of a lower monthly payment — the government says borrowers typically save $536 per month, better than $6,000 per year. The way this is done is that the borrower’s payment is reduced to 31 percent of their income. The cooperating lender lowers the payment to 38 percent. The 7-percent gap is made up with a government subsidy.
So what could go wrong? That government subsidy only lasts five years. Since the HAMP program began in 2009 we are now reaching the point where subsidies have begun to end for some HAMP borrowers and the result is that they are facing new and higher payments. How many borrowers? According to government figures, there are more than 775,000 HAMP borrowers.
The program is set up so that interest rates do not immediately jump back to previous levels, instead they increase in steps. The typical increase is expected to be $197 but for bigger loans the amounts could be substantially higher.
How to solve the problem? As a result of the higher monthly cost some borrowers may well face foreclosure, however there are several reasons to think the HAMP fall-out will not be too bad:
First, during the five years that the subsidies have been in place loan balances have declined as a result of amortization.
Second, if the typical borrower saved $536 per month for five years they have seen ownership costs fall by $32,160 ($536 x 60). Hopefully this money has been used to right-size household economics.
Third, in exchange for spending $4.4 billion on the program (of the $19.1 billion set aside), the government has saved nearly 800,000 homes from foreclosure. This helps homeowners, but it also helps lenders who would likely take huge losses and it also helps local communities because more foreclosures mean lower home values and thus reduced property tax collections.
The New Economy
It has long been assumed that as the economy improves it will provide widespread benefits. John Kennedy said: “a rising tide lifts all boats,” but somehow what we have now is a selective tide. As the National Association of Realtors points out, for the second quarter real estate values increased in 122 areas but fell in 47 metro markets. Between 1999 and 2012 household incomes dropped 9 percent, according to the Census Bureau.
These new economic realities mean that past assumptions are less certain than once thought. Go back to those HAMP borrowers who face higher monthly payments. An additional $197 a month should not be a major burden IF incomes are rising or at least holding steady, but if incomes are widely falling then all bets are off.
You can see the impact of our changing economy with first-time buyers. There are less of them. In July, says NAR, first-timers represented 29 percent of all existing-home buyers. In the past the usual standard was about 40 percent.
How can real estate demand increase when the pool of new buyers is slowing? Is it any wonder that rental rates are broadly rising? Should we be surprised that home sales are slower than in 2013?
These are tough questions for a tough real estate market.
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