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Posted on: 14th Mar 2014
RealtyTrac!
Stashed away in millions of homes is a ticking
financial time bomb. Of course, it didn�t seem this
way at first: When homeowners first lit the fuse home
equity lines of credit � HELOCs � were seen as a
way to quickly and cheaply access fast-rising home
equity, the just reward for homeownership. The problem
is that in the end a HELOC is nothing but a mortgage, a
loan which has to be repaid. And now, for large numbers
of homeowners, the time to pay-up has come. According
to Reuters, more than $220 billion in HELOC debt will
become earned, due and payable during the next four
years. Unfortunately, a lot of property owners will be
unable to pay-off such liabilities. Between 2000 and
2004, homeowner equity rose from $12.6 trillion to
$18.6 billion trillion. American real estate had been
rising at a fast clip and homeowners wanted to access
rising equity for several reasons:
First, it was there � trillions of dollars in
untapped equity. Financial gurus said not using that
untapped equity was an economic sin, an asset that
wasn�t working for the homeowner. Second, it was the
right debt to have because interest on HELOC financing
was tax deductible while taxpayers could not write off
the cost of credit card or auto debt. Third, HELOCs
represented quick access to large sums of capital,
perhaps enough to start a business, buy another house
or pay for a college education. Getting a HELOC was
virtually instant and automatic. Not only did borrowers
have real estate equity, such equity was growing. This
meant lenders had virtually no risk because the
security for the loan was increasing in value. Or at
least that was the thinking of the day. To make the
process easier, homeowners were bombarded with free
HELOC offers. Sign up today and lenders would pay all
closing costs.
When the mortgage meltdown hit it was borrowers with
first mortgages who were in trouble, typically property
owners who financed with toxic loans such as option
ARMs, interest-only mortgages and loans originated with
�no doc� mortgage applications. HELOC borrowers
drifted serenely along, largely untroubled by the
financial mayhem around them. HELOC borrowers lucked
out because their loans were typically structured like
credit card borrowing: As long as homeowners made
minimum monthly payments lenders were happy, the loan
was �performing� � at least on paper. Because
HELOCs were commonly far-smaller than first-mortgages,
the payments were very tolerable for most borrowers.
In addition, once the mortgage crisis was apparent
lenders curtailed large numbers of HELOCs. By 2006 it
was virtually impossible to get a HELOC, and by 2008
many lenders had severed credit lines. If you had a
$100,000 line of credit and $40,000 had been used the
balance was suddenly off limits. Most borrowers � if
not virtually all borrowers � did not know that
lenders had the right to curtail withdrawals when home
equity values declined. There was a lot of howling and
screaming when lenders closed the tap but for many
borrowers the curtailments were probably a good thing
because they limited debt.
Ten years ago was 2004, a time when real estate equity
was quickly growing. Spring forward to 2014 and a lot
of HELOC borrowers are about to be in trouble. The
reason is that HELOCs have to be repaid at some point
and for many borrowers now is the time. While HELOCs
are a form of real estate financing many, if not most,
were structured like credit cards: The lender was happy
to get a monthly minimum payment because that meant
more principal was outstanding for a longer period of
time so there was more interest to be earned. With
rising equity values repayment was not a worry because
in the worst case the property could just be
refinanced. Of course, if home values fell and
unemployment rose all bets were off � a lot of
borrowers would eventually be foreclosed. Many HELOCs
were structured so that there was a �draw period�
of five or ten years and then the rest of the loan term
was reserved for repayment. Others were simply 10- or
15-year notes, they end abruptly and whatever is owed
is owed. HELOCs routinely were in the form of an ARM
so that as interest rates rose or fell so too did
payment requirements. The good news for HELOC borrowers
is that the past few years have seen interest levels
crash to historic lows, something which cushions the
blow of unpaid HELOC debt.
What happens as HELOCs start coming due? For borrowers
the options range of gleeful to grim:
- The draw period ends and new monthly payments are
based on making the existing loan balance
self-amortizing over the remaining term of the loan,
perhaps 5, 10 or 15 remaining years. The result may be
sharply-higher monthly costs.
- The loan simply ends, say after 10 years. In effect,
the HELOC becomes a massive balloon note which must be
repaid.
- The HELOC debt is small so the borrower repays from
savings.
- The debt is small enough so the borrower is able to
repay by getting cash from credit cards. Not a low-cost
solution but better than foreclosure.
- Equity has been rising so the borrower sells the
property and repays the debt.
- The borrower contacts the loan servicer and gets the
loan extended for a year, postponing the problem.
- The borrower refinances both the first mortgage and
the HELOC, replacing two loans with one at today's
interest levels, possibly with federal help under the
Making Homes Affordable programs.
- The borrower settles the debt with a partial
payment. Problem: A big credit ding plus unpaid
mortgage debt may now be regarded as taxable income by
the federal government unless Congress restores the
Mortgage Forgiveness Debt Relief Act of 2007,
legislation which expired at the end of 2013. See a tax
pro for details.
- The borrower is unable to sell, refinance or pay off
the debt. The home is foreclosed. It's this last
option which is causing unease in the financial arena.
As RealtyTrac points out, despite rising real estate
values 9.3 million homes remain �deeply
underwater,� meaning the amount of debt with these
properties is at least 25% greater than the equity
value of the houses. It is these homes, especially,
which are most likely face foreclosure as long-dormant
HELOCs spring to life.
Stashed away in millions of homes is a ticking
financial time bomb. Of course, it didn�t seem this
way at first: When homeowners first lit the fuse home
equity lines of credit � HELOCs � were seen as a
way to quickly and cheaply access fast-rising home
equity, the just reward for homeownership. The problem
is that in the end a HELOC is nothing but a mortgage, a
loan which has to be repaid. And now, for large numbers
of homeowners, the time to pay-up has come. According
to Reuters, more than $220 billion in HELOC debt will
become earned, due and payable during the next four
years. Unfortunately, a lot of property owners will be
unable to pay-off such liabilities. Between 2000 and
2004, homeowner equity rose from $12.6 trillion to
$18.6 billion trillion. American real estate had been
rising at a fast clip and homeowners wanted to access
rising equity for several reasons:
First, it was there � trillions of dollars in
untapped equity. Financial gurus said not using that
untapped equity was an economic sin, an asset that
wasn�t working for the homeowner. Second, it was the
right debt to have because interest on HELOC financing
was tax deductible while taxpayers could not write off
the cost of credit card or auto debt. Third, HELOCs
represented quick access to large sums of capital,
perhaps enough to start a business, buy another house
or pay for a college education. Getting a HELOC was
virtually instant and automatic. Not only did borrowers
have real estate equity, such equity was growing. This
meant lenders had virtually no risk because the
security for the loan was increasing in value. Or at
least that was the thinking of the day. To make the
process easier, homeowners were bombarded with free
HELOC offers. Sign up today and lenders would pay all
closing costs.
When the mortgage meltdown hit it was borrowers with
first mortgages who were in trouble, typically property
owners who financed with toxic loans such as option
ARMs, interest-only mortgages and loans originated with
�no doc� mortgage applications. HELOC borrowers
drifted serenely along, largely untroubled by the
financial mayhem around them. HELOC borrowers lucked
out because their loans were typically structured like
credit card borrowing: As long as homeowners made
minimum monthly payments lenders were happy, the loan
was �performing� � at least on paper. Because
HELOCs were commonly far-smaller than first-mortgages,
the payments were very tolerable for most borrowers.
In addition, once the mortgage crisis was apparent
lenders curtailed large numbers of HELOCs. By 2006 it
was virtually impossible to get a HELOC, and by 2008
many lenders had severed credit lines. If you had a
$100,000 line of credit and $40,000 had been used the
balance was suddenly off limits. Most borrowers � if
not virtually all borrowers � did not know that
lenders had the right to curtail withdrawals when home
equity values declined. There was a lot of howling and
screaming when lenders closed the tap but for many
borrowers the curtailments were probably a good thing
because they limited debt.
Ten years ago was 2004, a time when real estate equity
was quickly growing. Spring forward to 2014 and a lot
of HELOC borrowers are about to be in trouble. The
reason is that HELOCs have to be repaid at some point
and for many borrowers now is the time. While HELOCs
are a form of real estate financing many, if not most,
were structured like credit cards: The lender was happy
to get a monthly minimum payment because that meant
more principal was outstanding for a longer period of
time so there was more interest to be earned. With
rising equity values repayment was not a worry because
in the worst case the property could just be
refinanced. Of course, if home values fell and
unemployment rose all bets were off � a lot of
borrowers would eventually be foreclosed. Many HELOCs
were structured so that there was a �draw period�
of five or ten years and then the rest of the loan term
was reserved for repayment. Others were simply 10- or
15-year notes, they end abruptly and whatever is owed
is owed. HELOCs routinely were in the form of an ARM
so that as interest rates rose or fell so too did
payment requirements. The good news for HELOC borrowers
is that the past few years have seen interest levels
crash to historic lows, something which cushions the
blow of unpaid HELOC debt.
What happens as HELOCs start coming due? For borrowers
the options range of gleeful to grim:
- The draw period ends and new monthly payments are
based on making the existing loan balance
self-amortizing over the remaining term of the loan,
perhaps 5, 10 or 15 remaining years. The result may be
sharply-higher monthly costs.
- The loan simply ends, say after 10 years. In effect,
the HELOC becomes a massive balloon note which must be
repaid.
- The HELOC debt is small so the borrower repays from
savings.
- The debt is small enough so the borrower is able to
repay by getting cash from credit cards. Not a low-cost
solution but better than foreclosure.
- Equity has been rising so the borrower sells the
property and repays the debt.
- The borrower contacts the loan servicer and gets the
loan extended for a year, postponing the problem.
- The borrower refinances both the first mortgage and
the HELOC, replacing two loans with one at today's
interest levels, possibly with federal help under the
Making Homes Affordable programs.
- The borrower settles the debt with a partial
payment. Problem: A big credit ding plus unpaid
mortgage debt may now be regarded as taxable income by
the federal government unless Congress restores the
Mortgage Forgiveness Debt Relief Act of 2007,
legislation which expired at the end of 2013. See a tax
pro for details.
- The borrower is unable to sell, refinance or pay off
the debt. The home is foreclosed. It's this last
option which is causing unease in the financial arena.
As RealtyTrac points out, despite rising real estate
values 9.3 million homes remain �deeply
underwater,� meaning the amount of debt with these
properties is at least 25% greater than the equity
value of the houses. It is these homes, especially,
which are most likely face foreclosure as long-dormant
HELOCs spring to life.
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