Next Up in Housing – A Huge Home Equity Payment Reset

Of all the screwed up, misallocated parts of the U.S. economy, the housing market continues to be one of the biggest potential train wrecks. While the extent of the insanity in residential real estate should be clear following the article I published yesterday, there are other potential problems just on the horizon.

One of these was written about over the weekend in the LA Times. In a nutshell, the next several years will start to see principal payments added to interest only payments on a large amount of second mortgages taken out during the boom years. The estimate is that $30 billion in home equity lines will reset next year, $53 billion in 2015, and then ultimately soaring to $111 billion in 2018.

I’m not a real estate expert by any means, so comments are encouraged and appreciated.

From the LA Times:

Some mortgage and credit experts worry that billions of dollars of home equity credit lines that were extended a decade ago during the housing boom could be heading for big trouble soon, creating a new wave of defaults for banks and homeowners.

That’s because these credit lines, which are second mortgages with floating rates and flexible withdrawal terms, carry mandatory “resets” requiring borrowers to begin paying both principal and interest on their balances after 10 years. During the initial 10-year draw period, only interest payments are required.

But the difference between the interest-only and reset payments on these credit lines can be substantial — $500 to $600 or more per month in some cases.

According to federal financial regulators, about $30 billion in home equity lines dating to 2004 are due for resets next year, $53 billion the following year and a staggering $111 billion in 2018. Amy Crews Cutts, chief economist for Equifax, one of the three national credit bureaus, calls this a looming “wave of disaster” because large numbers of borrowers will be unable to handle the higher payments. This will force banks to either foreclose, refinance the borrower or modify their loans.

Financial regulators, including the comptroller of the currency, are aware of the coming bulge in high-risk resets and have been urging the biggest banks to set aside extra reserves for possible losses. Last month, Citigroup said it was increasing reserves on its nearly $20 billion in home equity lines and acknowledged that the reset payment shocks for borrowers could be a major challenge.

Full article here.

In Liberty,
Mike

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10 thoughts on “Next Up in Housing – A Huge Home Equity Payment Reset”

  1. A ton ’04/’05 interest only 5/1 libor ARMs hit the 10yr mark as well….even though the rate on most are under 3%….payment shock will hit the alt -A borrowers that didn’t walk away, refi or short sell.

    Reply
  2. I’m not sure to what extent 2nd’s can force foreclosure, especially with HAMP/HARP refi’s. We would have to get ahold of documentation for the HOMEQ’s and see what rights the covenants afford. I know I’ve heard ads on the radio here in Denver for new HARP programs which enable borrowers to refi at low rates, take out more than the value of the home and cram-down 2nd liens. Again, I have not verified exactly how those work.

    Whether the 2nd’s can force foreclosure or not, this will still be a big problem. I’m sure there’s a big big reservoir of home owners who would have tried to sell on this housing bounce who have not because they can’t get whole because the 2nd mortgage.

    WFC is the largest home equity lender and as of Feb it had home equity “assets” equal to 92% of tier 1 capital, with 34% underwater.

    Good find on home equity paper. I’ve been ignoring it because I’ve been assuming the Govt would HAMP/HARP away the HELOCs

    Reply
    • Doesn’t matter to a degree. They just send their standard letters threatening foreclosure and the like and the homeowner may crumble like a pile of dust.

    • It already is being used to absorb the losses because a large porton of those loans are in default anyway and the banks who service them are required to step in and make the payments it they’re in HELOC pass-thru’s, which most of them are. After a certain level of capital loss, the HELOC trust can “put” the loans to the banks, which is why they changed the mark to market rules in order to let the banks phony-up the marks so the wouldn’t get put the paper.

      If you don’t think there will be adverse consequences once guys like Buffet force the Government to bailout the paper, then please continue reading Alice in Wonderland.

  3. My HELOC loan reset in August and went from $375 per month to $1640 per month. I will have to assume that this is fairly typical and that most people won’t be able to cover such an increase. I dealt with the difference by dropping my health insurance policy for my family, which was about $1200 per month. Irony of all ironies, my policy was dropped anyway due to the new ObamaCare rules. You asked for input, Mike. Here it is. And keep up the good work!

    Reply
  4. HELOCs were generally high FICO borrowers…the weaker credits went into fixed rate 2nds…i dont think the author’s view is sufficiently researched.

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    • Not quite. Many got their 2nd’s and 3rd’s during the boom years either at purchase (80/20 w/a cash back deal) or 2-3 years after such and were able to “keep up” for the past few years even if scraping by at times. Once those reset it’s over unless the whole thing can be re-fi’d over. And that requires having #1 willing to do such if the HO hasn’t been late or defaulted in any way shape or form at bare minimum.

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