The pre-crisis surge in mortgage debt during the mid-2000s was partly fueled by home equity lines of credit (HELOC) loans, which saw borrowers take advantage of the rapid run-up in home prices to extract cash from equity.
Borrowers took cash-outs for a variety of reasons, sometimes with little thought to long-term consequences. HELOC loans were typically originated as 10-year interest-only loans that switch to fully amortizing loans after a decade.
Economists, bank regulators and consumer advocates are increasingly concerned about the monthly payment shock that will hit borrowers at the end of the interest-only period. That’s when they have to pay back both interest and principal, resulting in higher monthly payments.
The majority of HELOCs were originated at the peak of the home equity boom between 2004 and 2006, so there is concern of an oncoming wave of defaults when the estimated $190 billion in HELOC loans reset between Q4 2014 and 2017, according to CoreLogic, which has examined the potential impact of the HELOC payment shock and the likelihood of a big spike in loan defaults.
CoreLogic concludes that the impact of the payment shock will be minor and not a drag on the broader market. It is expected that the impact will be minor for a few reasons, CoreLogic says. Here are the biggest reasons:
>>> The size of the $190 billion reset is very small relative to the $9.9 trillion mortgage market.
>>> 25 percent of HELOCs are in the first-lien position, meaning there is no other associated debt.
>>> The major dual triggers of default, negative equity and unemployment are improving.
How much have these “triggers of default” improved? CoreLogic says that the negative equity share for first liens with a home equity loan is 22 percent, well below the 36 percent rate four years ago, and continues to improve.
The unemployment rate in 2010 was more than 9 percent, but it has since declined to under 6 percent.
“Adjusting for the first-lien position and negative equity means that the HELOC exposure shrinks from $190 billion to $31 billion,” CoreLogic says. “While the spike in defaults at the 10-year mark certainly is an issue for those borrowers experiencing the reset, from a macro perspective the impact will not be a wave, but small ripples.”