Are Heloc defaults about to spike?

November 26, 2013

Peter Rudegeair is worried about Helocs. In particular, he’s worried about all the home equity lines of credit which were written in the run-up to the financial crisis, and which are now beginning to turn 10 years old. When they do that, their default rates have a tendency to spike, since most borrowers have to start paying down their principal after ten years.

Here’s the chart, which I put together from FDIC data; the red line marks the ten-years-ago point.

Rudegeair’s point is that we’re only just embarking on the 10th anniversary of the run-up in Heloc issuance. What’s more, a large proportion of the Helocs issued between 2003 and 2008 went to subprime borrowers. Because they’re credit lines, they don’t need to get paid down, at least for the first ten years. And so as these loans hit their tenth birthdays, millions of borrowers around the country are going to start being faced with new mandatory repayments. Which they might not be able to afford:

After 10 years, a consumer with a $30,000 home equity line of credit and an initial interest rate of 3.25 percent would see their required payment jumping to $293.16 from $81.25, analysts from Fitch Ratings calculate.

That’s why the loans are starting to look problematic: For home equity lines of credit made in 2003, missed payments have already started jumping.

Borrowers are delinquent on about 5.6 percent of loans made in 2003 that have hit their 10-year mark, Equifax data show, a figure that the agency estimates could rise to around 6 percent this year. That’s a big jump from 2012, when delinquencies for loans from 2003 were closer to 3 percent.

This is worrying — but I’m more sanguine than Rudegeair. Firstly, delinquency rates on Helocs naturally go up over time. As the best borrowers pay off their loans, and as people sell their homes for whatever reason, the denominator shrinks. The 5.6% delinquency rate for is a percentage of outstanding 2003-vintage Helocs, not a percentage of all the Helocs which were written that year. What I’d really like to see is the chart above, but with each bar split in two, showing what proportion of total outstanding Helocs are more than ten years old. We don’t know that number, and until we know that number, it’s hard to tell how big the problem is.

Secondly, what we can tell from the chart is that total outstanding Helocs are falling at an impressive rate — in fact, they seem to be falling, right now, nearly as fast as they were rising in the final years of the credit bubble. That’s partly because banks are writing off loans when underwater homes are sold, it’s partly because borrowers are paying down their loans, it’s partly because borrowers are refinancing their loans as the property recovery gives them a bit more equity, and it’s partly because borrowers are paying off their loans entirely, as they’re forced to, for instance, when they move. So even if delinquency rates start to rise, they’re going to be rising only as a proportion of a shrinking pool of Helocs.

Finally, we can also see from the chart that the banks have a few years’ experience already, in terms of seeing what happens to ten-year-old Helocs. The big rise in Heloc issuance doesn’t date back to the end of 2003; it’s much older than that, and really goes all the way back to the end of 1999. So the banks have the data they need — and their reaction to that data has been to ramp up their Heloc issuance. According to Moody’s Analytics, Heloc originations are likely to rise 16% this year, and will hit another five-year high in 2014.

Looked at in that light, if the total amount of Helocs outstanding is falling even as the number of new Helocs is rising quickly, it stands to reason that the amount of churn is higher than you might think, and that ten-year-old Helocs make up a pretty low proportion of the whole. This is borne out by Rudegeair’s own numbers: he has $1.3 billion in Helocs turning ten years old at Citibank in 2014, $4.5 billion at Wells Fargo, and $8 billion at Bank of America. That’s less than $14 billion between those three big banks, compared to a $518 billion total pool of Helocs. Even if delinquencies on that $14 billion hit 9%, that’s still a mere 0.2% of total Helocs outstanding.

As Rudegeair says, if interest rates rise and default rates spike along with them, those numbers could yet rise. But for the time being, they’re entirely manageable. Especially considering the fact that interest rates on Helocs are floating-rate, which means that the performing loans will be paying more money even if the defaulting loans cause losses. Besides, we’re still recovering from the last credit crisis. It’s far too early to have a new one.


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