Home equity lines of credit initiated during the run-up of the housing market turn 10 this year. It’s not a birthday anyone is particularly celebrating, but one in which lenders are still making a silent wish before blowing out the candles.
The wish? That borrowers will keep the payments coming. Unfortunately, the reality is some homeowners will not, and lender balance sheets could suffer as a result. What remains to be seen is whether delinquencies and defaults will spike this year and into the next few years.
Home equity lines of credit, or HELOCs, are revolving lines of credit that allow a homeowner to borrow up to a maximum amount against their home equity, usually at a variable interest rate. The numbers of HELOCs that will begin to amortize will rise sharply over the next four years, according to data from Citigroup in a regulatory filing. Citigroup, for example, will see $1.3 billion in HELOCs amortize this year, up from just $500,000 in 2013. Citi said its HELOC resets are expected to peak in 2016 at $5.4 billion.
Other banks expect to see similar trends as many of the HELOCs set for amortization were written as the housing market was heated and before the economy tanked, or from roughly the 2004 to 2007 time period, generally with 10-year amortization periods. Borrowers typically use HELOCs to finance major expenses such as college, home renovations or debt consolidation.
The fact that HELOCs are back in the news isn’t necessarily all bad. HELOC originations are on the rise — an opportunity for consumers to tap into rising equity. It’s also an opportunity for lenders to provide a form of credit that has been mostly dormant since the housing crisis, thanks to an improving housing market and strengthening economy.
Though new HELOC originations are expected to grow this year, regulators and the mortgage industry will likely focus most of their attention toward older HELOCs and the risk of rising delinquencies and defaults.
Regulators have been sounding alarm bells for a while on HELOCs initiated during the height of the housing bubble. They are concerned that losses at financial institutions could spike over the next four years as these HELOCs reach the end of their draw periods. Because HELOCs generally are a borrower’s second mortgage, lenders recover little if anything on a HELOC if a home is foreclosed. That’s because most of the proceeds would go to pay off the first mortgage.
HELOCs from 2004 with 10-year draw periods amortize this year. That means homeowners’ interest-only monthly payments will be adjusted to include principal balance payment requirements.
The result could be significant payment shock when the monthly bill arrives, with some reports suggesting payments could triple.
The Office of the Comptroller of the Currency estimates $29 billion of HELOCs will reach their end-of-draw period this year. That number will rise to $52 billion in 2015, and $62 billion in 2016 before peaking at $68 billion in 2017.
DISCLOSING RISKS
More than 75% of outstanding home equity products were initiated between 2004 and 2009, according to Black Knight Financial Services (formerly Lender Processing Services). Many of these products reside with the nation’s biggest banks, which have begun disclosing information about potential HELOC exposure in their financial filings.
Wells Fargo said in its third-quarter earnings report that it is continuing to monitor potential risk from HELOCs. Wells Fargo has $4.5 billion in HELOCs that will reset this year. That number will rise significantly in 2015 and again in 2016 before leveling off in 2017 at $9.1 billion, the bank said.
Citigroup’s home equity loan portfolio of $32.8 billion includes about $19.6 billion of home equity lines of credit that have not yet reset, according to Citigroup’s 3Q earnings report. The average FICO score for HELOCs that will amortize between 2013 and 2014 was 719, significantly lower than new HELOCs being originated in the post-housing crisis marketplace.
“Based on the limited sample of revolving HELOCs that has begun amortization, Citi has experienced marginally higher delinquency rates in its amortizing home equity loan portfolio as compared to its non-amortizing loan portfolio,” Citi said in SEC filings. “However, these resets have generally occurred during a period of declining interest rates, which Citi believes has likely reduced the overall ‘payment shock’ to the borrower. Citi continues to monitor this reset risk closely, particularly as it approaches 2015.”
The good news is that delinquencies on HELOC balances were at or near historic lows with delinquency rates below 1% at the end of the third quarter of 2013, according to credit reporting agency Experian, said Alan Ikemura, senior product manager with the Decision Analytics division at Experian. Short-term delinquencies — those payments that are less than 60 days overdue — stood at 0.75%, while long-term delinquencies — those between 90 and 180 days late — stood at 0.63%, according to Experian data.
Black Knight also reported declining home equity delinquencies in its most recent “Mortgage Monitor” report from October 2013. Still, it also noted that new problem loans in amortizing vintages were on the rise and that credit scores associated with 2004-2008 HELOCs are lower now than they were at origination. Unpaid principal balances during that time period are higher than periods before or after that time frame.
“A lot of the market is concerned about draw periods coming up on older HELOCs taken up during that boom time,” Ikemura said. But so far, Experian hasn’t noticed anything too troubling in a vintage analysis of HELOCs. It tracked a set of 30-year HELOCs originated in 2007 with draw periods of five years but saw no explosions in defaults when the draw periods ended.
MITIGATING THE RISK
Banks and mortgage lenders have been heeding regulators’ warnings and implementing loss-mitigation efforts.
Some borrowers who regained equity as home prices rose were able to get out of their HELOCs before they amortized by refinancing their homes and exiting the HELOC. Others may have refinanced into a new HELOC to shield themselves from payment shock.
Regulators have encouraged lenders to offer a variety of loss-mitigation options to borrowers to avoid defaults. That could mean modifying the terms of the HELOC, for example, so that principal payments that were scheduled to hit this year begin at a later date.
Financial institutions appear to be heeding that call with educational outreach and mitigation efforts.
JPMorgan Chase said in a regulatory filing that it has taken action to close or reduce the undrawn line in some HELOCs when borrowers are exhibiting a material deterioration in their credit risk profile or when the collateral doesn’t support the loan amount.
In a recent regulatory filing, JPM estimated that its home equity portfolio contained approximately $2.4 billion of high-risk HELOCs where the borrower has a first mortgage loan that was delinquent or had been modified. JPM’s portfolio includes HELOCs initiated by failed thrift Washington Mutual, which it acquired during the financial crisis. JPM said the delinquency rate of HELOCs that had reached reset was 2.71% in 3Q, down from 4.42% a year ago.
At Bank of America, HELOCs that have entered the amortization period have experienced a higher percentage of early-stage delinquencies and nonperforming status when compared to the HELOC portfolio as a whole, the bank said. At the end of 3Q 2013, $69 million, or 3% of outstanding HELOCs that had entered the amortization period, were 30 days or more past due compared to 1% for the entire HELOC portfolio. It said $201 million, or 9%, of outstanding HELOCs that had entered the amortization period were nonperforming compared to 4% nonperforming for the entire HELOC portfolio. The bank has a HELOC portfolio with an outstanding balance of $82.3 billion.
The risk of nonperformance will likely rise in later years as more than 85% of BofA’s HELOCs will not be required to make a fully-amortizing payment until 2015 or later.
NEW LOAN PRODUCTION
On the origination side of HELOCs, lenders see opportunity knocking. With the financial crisis now largely in the rearview mirror, consumers and lenders are poised to capitalize on a growing economy, according to a recent report from Moody’s Analytics.
Moody’s Analytics data shows that credit cards, not HELOCs, will be the favored source of revolving credit going forward, despite a nascent HELOC origination market.
“Credit card balances are expected to rise modestly over the next year as an expanding economy builds confidence and increases consumer spending,” the Moody’s report said. “Households have fewer borrowing options than they did in the past because of the decline of home equity and stricter limits on home equity loans and lines of credit.”
Still, despite a tight lending environment, large and small lenders have begun to originate HELOCs as the economy gains steam.
At Bank of America, for example, home equity loan production increased to $1.8 billion in 3Q 2013 from $933 million in 3Q 2012, according to a regulatory filing.
Smaller lenders also look to capitalize on the trend. Karlton Uhm is a senior mortgage broker at direct lender Peoples Home Equity, based in Nashville. The lender is licensed in 26 states.
“I think it’s a good opportunity for us to explore HELOCs again,” Uhm said.
“There has been a resurgence in the market for HELOCs over the last year,” he said. “We’ve seen a lot more activity.”
Consumers have equity they can tap that they might not have had a couple of years ago due to rising home prices, and lenders are finding ways to help consumers who don’t have 20% available for a down payment, he said.
One area of rising interest is in the jumbo market where Peoples is helping borrowers use HELOCs to get their loan within the conforming loan limit.
Say, for example, someone buys a home priced at $550,000. If they put 10% down, that leaves $495,000 to be financed through a mortgage, but the conforming loan limit is $417,000. By taking out a HELOC, the borrower can get the first mortgage under the conforming loan limit.
They would take out a first mortgage of $417,000 and a $78,000 HELOC to qualify for a conventional loan with better pricing.
Because the new qualified mortgage requirements don’t apply to HELOCs, the HELOC becomes advantageous because it isn’t part of the qualified mortgage costs and avoids the monthly private mortgage insurance payments, Uhm said.
Peoples has fashioned mortgages with a 75% LTV first mortgage, a 15% HELOC and a 10% down payment. The 75% LTV provides for the best loan pricing, he said.
The homeowner with such an arrangement has the flexibility of having that HELOC in place, which can potentially be used for future financial needs over a five- or 10-year draw period.
“I think the HELOC will be advantageous in this QM market that is developing,” Uhm said. “It’s an evolution. We have to become creative in how we are going to lend in this more restrictive environment. It’s restrictive in a good way until we know where the happy medium is in minimizing losses and increasing homeownership.”
STRONGER CONSUMERS
Household balance sheets improved throughout last year as falling debt levels stabilized and even grew in the latter half of the year, according to Moody’s, all of which bodes well for future lending. Household debt contracted by $1.5 trillion from peak to trough through the Great Recession and the economic recovery to rest at slightly less than $11 trillion — a level not seen since 2006, Moody’s said.
Most of the decline — 85% — Moody’s attributed to defaults in first mortgages, home equity loans and HELOCs. Only a small share of the debt contraction is attributable to amortization and accelerated payments. The report does not separate out HELOC defaults. Moody’s expects deleveraging on mortgages, including HELOCs, to be mostly over, with a slight uptick in consumers’ mortgage balance sheets expected in 2014.
“Though income growth has been stagnant, households are having an easier time making debt payments,” wrote Cristian deRitis, author of the Moody’s report.
“Lower debt levels, along with record low interest rates, have pushed the monthly debt service ratio—the ratio of minimum monthly debt payments to personal disposable income—to the lowest levels since the early 1980s.”
At Experian, Ikemura said consumers appear to be doing a better job at managing their credit.
“We are seeing really great performance across the board, whether it be in autos or bank cards — everything,” he said. “If there is any takeaway from the recession, at a high level, consumers overall have learned how to better to manage their money and that flows into managing HELOCs as well.”
