As the wave of resets for home equity lines of credit continues to rise, many homeowners are left with higher monthly mortgage payments.
This situation stems back to the increased demand for second mortgages during the financial crisis. Homeowners sought to take cash out of appreciating homes or finance purchases without private mortgage insurance, pushing demand to historic levels.
Right now the debate revolves around if the market, and better yet borrowers, can handle this looming increase in payments.
According to a recent panel discussion held by the Urban Institute's Housing Finance Policy Center, “The volume of outstanding second mortgages peaked in 2007, at the height of the housing boom, at just over $1.1 trillion. Piggyback loans–second liens that accompany a first lien at signing, also known as “simultaneous seconds” — were a staple of the time, with as many as 45% of purchasers in coastal and bubble areas using a piggyback loan to subsidize the down payment on a first mortgage, hoping to eliminate the need for mortgage insurance.”
These types of second liens came in both home equity lines of credit and closed-end seconds.
The Urban Institute quoted CoreLogic’s Sam Khater saying, most HELOCs are interest-only loans with a 10-year reset period. Essentially, the borrower pays the interest only for ten years; at the end of year ten (month 120), the borrower begins paying principal as well, so monthly payments spike.
Does this mean the housing market is in for rough times again? Khater said that it doesn’t, for four reasons:
- The 25% of HELOCs that are were originally taken out as first liens will be more resilient, as the LTV on the property is apt to be lower;
- Prepayments on HELOCs will likely also spike at the ten-year mark as borrowers anticipating the payment shock pay off or refinance the entire loan;
- When HELOCs reset, the absolute delinquency rate generally rises to only about 6%, and the balances affected are quite small;
- The economy is improving and negative equity is down, so performance post-reset is likely to improve in the years ahead.
Demand for HELOCs is at the highest level since the 12 months ending June 2009, according to RealtyTrac.
“This recent rise in HELOC originations indicates that an increasing number of homeowners are gaining confidence in the strength of the housing recovery and, more importantly, have regained much of their home equity lost during the housing crisis,” said Daren Blomquist.
But not everyone agrees that this surge in demand is a good thing.
Lynn Effinger, executive vice president of business development for ZVN Properties, wrote an exclusive blog for HousingWire in response to the RealtyTrac report, saying that the number of homeowners getting HELOCs signals that many who have seen some return of equity to their home may be tapping into it to offset higher costs and stagnant wages, or even loss of income.
While what Blomquist said may be true in many cases, Effinger said he would point to still higher-than-reported unemployment and underemployment numbers and ample reports about middle-class stagnant wages as another reason for increased HELOC activity.
In addition, during the Institute of International Finance Membership meeting in Washington D.C., JPMorgan Chase (JPM) CEO Jamie Dimon said there isn’t a lot that will keep the U.S. economy down. But the one thing that could derail the recovery: The $3.2 trillion nonbank financial system, or “shadow banks.”
“Just as HELCOCs were a contributing factor to the housing crash, so too was nonbank lending, as many such firms so often made low-quality loans to many borrowers who were incapable of or did not choose to pay for, which caused a plethora of defaults,” Effinger said. “These are just two factors threatening to halt what little momentum some believe there is with respect to the housing “recovery.”