Residential real estate lending was the leading component of the Great Recession of 2007-2009. Could it happen again? Let’s analyze our Intelliview data to see where U.S. lending trends are headed with HELOCs.
A large portion of Home Equity Lines of Credit (HELOCs) were originated from 2004 to 2007. The term structure of these HELOCs will soon result in larger monthly payments, which could potentially promote consumer debt burden troubles. Additionally, with as much as 13% of all first mortgage customers having balances greater than the value of homes, many HELOCs wallow underwater.
HELOCs typically have a ten year draw followed by a twenty-year repayment period. However, there are variations in the term structures. HELOCs can have as little as a five year draw, while others have a fifteen year repayment period. During the draw period, customers only pay interest on the balance. In the repayment period, the account functions like a loan, customers pay principal and interest.
In 2012, the Office of Comptroller of the Currency (OCC, the primary banking regulator) reported that 58% of all bank HELOC balances would enter the repayment period and begin to amortize between 2014 and 2017 (OCC, Semiannual Risk Perspective, Spring 2012). This report renewed fears that the increase in payments would lead to higher delinquencies and foreclosures, limit consumer spend and provide a drag on the U.S. economy.
Paradoxically, the OCC estimates of the HELOC balances entering the repayment period may be low. The OCC has accounted only for $392 billion of HELOC balances among banks. Experian’s review of all HELOC trades shows a significantly higher level of balances. Additionally, American Banker estimates the top 200 banks and thrifts had more than $477 billion in HELOC outstanding as of the end of 2013, with the top three lenders (Bank of America, Wells Fargo and JP Morgan Chase) comprising nearly $300 billion.
Experian examined HELOCs in the four states with the greatest surges in home values and lending prior to the Great Recession. California comprises nearly 19% of all HELOC balances and lines. With averaging HELOC balances of 53% above the national mean, Arizona, Florida and Nevada are the three highest utilization rates by state. Nevada has the highest 30+ day delinquency rate in the country at 2.92%, while the national average is 1.64%.
According to CoreLogic’s most recent home price index report, Nevada, Florida and Arizona home prices remain 30-39% below their peak real estate values. California’s prices are down 17%, and the national average home value is still 14% below its highest value. Refinancing HELOCs may be difficult due to the significant number of second liens still underwater. Compounding this difficulty, lending standards also have tightened, with regard to loan-to-value, debt ratios and credit quality.
The average HELOC was examined at a 4.5% interest rate and a 20 year repayment period. The average monthly payment increases almost 69% when the account leaves the draw period and requires paying principal balance as well as interest. This payment increase accounts for approximately 2.6% of the median U.S. household gross annual income.
It is estimated that the increase in HELOC payments will comprise $1 billion in additional annual payments during 2014, and an additional $9 billion between 2015 through 2017. However, it is important to remember that not all HELOCs will reach repayment.
HELOCs are priced based on the prime rate. That rate has been 3.25% for more than five years, a historical low. When prime rate reached this level in December 2008, the rate was at its lowest in 53 years. Only 18 months prior to reaching 3.25%, the prime rate had been 8%.
If the prime rate increases by 1% to 4.25%, the average payment of accounts in the draw period would increase 22%, affecting just about every HELOC, with a national increase in annual payments of about $5 billion.
The volume of HELOCs that are beginning to enter the repayment period may eventually increase delinquency rates. However, no such increase is yet evident. As shown below, delinquency rates are steady after a long decline. In the past three years, 90+ days delinquency has declined 41%.
The Majority of HELOCs are second mortgages. Successful completion of a foreclosure would involve making the customer’s monthly first mortgage payment in addition to all other expenses incurred in foreclosure and the sale of the property. Very often foreclosing from a second lien does not make financial sense unless the financial institution also holds the first mortgage on the property.
As a large portion of HELOCs enter the repayment period in the next four years, the payments that customers must make will increase considerably. With interest rates as low as they are, the prime rate will eventually rise, and increase debt service ratios. These payment increases will have implications on consumers, lenders and the economy. Having grown 10.5% in the last year, home values continue to recover from the recession. It is yet to be determined whether this payment increase will have a broader or more isolated impact. In the meantime, HELOCs will continue to see their resurgence.
For more insight like this from Experian Decision Analytics, watch our 2014 Q1 Experian–Oliver Wyman Market Intelligence Report presentation.