A decade after homeowners used a soaring real estate market to go on a borrowing binge against their own home equity; many across the country are now falling behind on their payments. This looming crisis threatens to leave banks on the hook for hundreds of billions of dollars.
Borrowers who took out Home Equity Lines of Credit, or HELOCs, when home prices were near their peaks in 2004-2008 are struggling to keep up as principal finally comes due after years of interest-only payments.
With a HELOC, consumers borrow against the equity they have in their home. Typically, HELOCs are structured such that the borrower makes interest-only payments for the first 10 years. After that, the borrower has to begin to pay back the principal as well as interest.
When the HELOC interest-only payments end and the borrower has to pay interest plus principal, the homeowner’s monthly payment will automatically increase by hundreds or even thousands of dollars a month. For the earliest HELOCs, the 10-year interest-only period has already come to an end. The problem is that millions more Americans will see their monthly mortgage payments skyrocket in the next few years.
From the beginning of 2005 to the end of 2007, roughly 10.8 million HELOCs were originated. In the 4Q of 2005 alone, nearly $130 billion of HELOCs were issued. The average amount of a HELOC loan in those three months was more than $130,000.
When the sub-prime market began to collapse in the spring of 2007, originations of HELOCs continued unabated for more than a year through the middle of 2008. According to Equifax, the total of outstanding HELOCs did not peak until late 2009 at $672 billion of cumulative issuance.
Some of these bubble-era HELOCs were taken out by homebuyers as so-called “piggy-back” second mortgages at the time of purchase. This enabled them to purchase a home with little or no down payment. However, the vast majority were originated after the home purchase – usually within two years.
Millions of homeowners were not content with taking out a single HELOC. Many subsequently refinanced their HELOCs – some more than once – to take advantage of rising home values and pry still more cash out of their house. Between 2004 and 2006, roughly six million HELOCs were refinanced around the country. California was the center of this HELOC madness.
HELOCs lured in millions of homeowners between 2004 and 2008 because the interest-only monthly payment was not very much – often only a few hundred dollars a month. Why worry about the fact that in 10 years the loan would become fully amortized when home values were soaring by double digits? Now we have a potential crisis on our hands.
Millions of HELOCs to Reset in the Next Few Years
So, do we know how many bubble-era HELOCs will be recasting into fully amortizing loans in the next few years? Estimates vary widely. Obviously, HELOCs that originated in 2004 and 2005 have already reset. Those originated in 2006-2008 will be resetting between now and the end of 2018.
According to Equifax, there are roughly 4.2 million HELOCs still outstanding from the four peak-bubble years. Equifax estimates that there were a combined total of 11.2 million HELOCs outstanding in August 2015 with a remaining balance of roughly $500 billion.
The question is, how ugly can it get? Let’s examine the situation of a real borrower whose plight was discussed in an article in the Los Angeles Times. The homeowner took out a $167,000 HELOC in 2006 on his Huntington Beach, California condo. Last year he received a notice from his mortgage servicer that his HELOC would convert to a fully amortizing loan in July 2016, and his monthly payment will soar from $400 to more than $1,100.
The shocked homeowner said, “We both now live on fixed income and will not be able to make the payment.” So this homeowner will almost certainly have to sell his home sometime this year. There are millions of others who are in the same boat.
It remains to be seen if the coming HELOC blow-up will lead to the next financial crisis, as potentially millions of American homeowners have to sell their homes or default on their loans and see their homes foreclosed upon by their lenders.
In many parts of the country, home prices are still not back to their bubble-era valuations. So this could cause serious problems for banks, S&Ls and other financial institutions that originated – and still own – very large amounts of HELOCs.
I don’t see much written about this potential crisis in the financial media, so I wanted to bring it to my readers’ attention today. Keep in mind that the above is just a brief summary of a very complicated issue.
Gary D. Halbert is the president and chairman of Halbert Wealth Management, Inc. His Forecasts & Trends Weekly E-Letter may be obtained free of charge by subscribing at www.halbertwealth.com