Concerns that borrowers coulddefault en masse on home equity lines of credit are overblown, according to a report released Thursday by the credit bureau TransUnion.
Though some borrowers will suffer from payment shock when home equity lines reach their end-of-draw-period after 10 years, the risks are isolated, TransUnion found. Fewer than 20% of home equity lines have an "elevated risk" of default in the next few years.
Many borrowers pay interest only on home equity lines and may be unable to absorb a higher payment that includes principal. Still, many banks, credit card and auto lenders have tools to identify which consumers can absorb the higher payments.
"Everyone needs to take a deep breath because the risks of home equity lines resetting are manageable," said Ezra Becker, a vice president of research and consulting at Chicago-based TransUnion. "The concern is perhaps overblown because the economy now supports a more moderate view."
During the downturn, when home prices were falling, many borrowers lost their jobs and were unable to pay more than interest on their HELOC or could not refinance. Now the opposite is true, Becker said. Many financial institutions are actively identifying borrowers with HELOCs due to reset, based on credit scores and combined loan-to-value ratios, and now are refinancing those loans, he said.
"The world is not falling apart on HELOCs because there are ways to manage the risks," Becker said.
As of June 30, Bank of America had $89.7 billion in outstanding home equity loans, the most of any bank, while Wells Fargo had $80 billion of home equity loans.
B of A 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 told Bloomberg. Those programs include loan modifications which could entail principal reduction, he said.
About 76% 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% on loans after the reset period compared with a 1% rate for loans in the interest-only phase.Regulators have been sounding an alarm for a couple of years about the risks of defaults on HELOCs taken out during the run-up in home prices between 2004 and 2008.
In July, federal and state regulators issued joint guidance encouraging financial institutions to "effectively communicate with borrowers" about pending HELOC resets. The guidance indicated that banks should have systems in place to understand their exposure.
The Office for the Comptroller of the Currency has estimated that $30 billion in HELOCs will reach the end of their initial draw period in 2014. But the numbers jump dramatically going forward to $52 billion in 2015, $62 billion in 2016 and $68 billion in 2017.
"There is no reason for any financial institutions to be blindsided by this," Becker said.
Roughly 16 million consumers hold a combined $474 billion in HELOCs as of December 2013. Of those, between $50 billion to $79 billion have an elevated risk of default. Credit scores are still a great predictor of defaults, Becker said. Borrowers with credit scores between 600 and 639, which represent just 7% of all HELOC borrowers, had a default rate of 4%. But that number jumped to a 30% default rate for borrowers with credit scores below 600, he said.
A surprisingly large number of HELOC borrowers have no idea when their end-of-draw period is, so they do not know the point when they can no longer borrower funds from the line of credit and must repay the outstanding balance with fully amortized payments.
The study also used home price data from CoreLogic to determine which borrowers had significant equity in their homes to avoid a HELOC default. Financial institutions also can determine which borrowers can manage a large HELOC payment by understanding consumer cash flows.
Given the repercussions from the financial crisis it is perhaps not a surprise that credit card and auto lenders need to pay attention to HELOC resets.