The mortgage crisis is once again subverting the traditional understanding of consumers' debt-payment priorities.
A few years ago, eyebrows rose when homeowners began falling behind on their mortgages, risking the loss of their homes, while continuing to pay their credit card debts. The new paradox: defaults and loss rates on home equity loans remain low compared with those of first mortgages, which historically were considered safer.
The counterintuitive trend suggests that losses many had expected the banking industry to suffer on home equity loans will not come to pass. "If we are going to get into a major increase in [home equity] loan losses at a time when the economy is recovering, it would be an aberration," says Richard Bove, an analyst with Rochdale Securities LLC. "Home equity is a very profitable business because 95 out of every 100 borrowers are still paying."
According to Lender Processing Services Inc., the 30-to-89-day delinquency rate on home equity loans held by banks and thrifts slid from a peak of 1.78 percent at the end of 2008 to 1.32 percent on Dec. 31. For first mortgages, the rate also declined over the same period but less steeply, hovering around 3 percent.
The differences are starker in the noncurrent rates, which capture loans 90 days overdue or in nonaccrual status. They've flatlined below 2 percent for home equity while soaring above 9 percent for first mortgages.
One explanation for why consumers would continue paying second mortgages while allowing first ones to slide is that they want to remain in good standing as best they can, so they pay as many bills as possible each month. Payments on a second mortgage are typically more affordable than those on the first.
Also, some borrowers use home equity lines of credit for day-to-day expenses, and others want to make sure they have the option.
Another interpretation is that banks are granting these loans only to more creditworthy borrowers. "We're assuming that everybody who has a HELOC has a first mortgage, and that they're all the people who are in trouble, which is not necessarily the case," says Bill Moreland, president of PeerMetrics Inc. in Dallas. Plus, he says, many HELOCs or second mortgages are for small business owners who couldn't get small-business loans.
Bove says some borrowers are misinformed and believe paying home equity loans will somehow delay foreclosure. The government may have fed such misperceptions by failing to address second liens when it started the Home Affordable Modification Program a year ago, he says. "The consumer believes that if they keep the home equity payment going, something will be done on the first mortgage to assist them in staying in their home."
The reluctance of the four largest banking companies, which hold more than half of all home equity loans, to write down principal on those assets has been blamed for the slow pace of loan mods. Those four-Citigroup, Bank of America, JPMorgan Chase & Co., and Wells Fargo-also happen to be the top servicers of first mortgages. In August, the government unveiled 2MP, a supplemental program to HAMP in which companies agree to reduce a borrower's second-lien payment if the first lien has also been reduced. Since then only BofA has signed up for 2MP, compared with 106 servicers participating in HAMP.