The risk aging home equity lines of credit carry for individual lenders and the economy is both better and worse than many feared.
TransUnion, one of three leading nationwide credit data firms, researched the topic and found the overall default risk of these loans to be very small, in large part because the economy has strengthened and the loan volume has remained relatively small.
Nevertheless, Transunion found the risk to individual lenders remained potentially significant.
According to the Chicago based firm's data, $438 billion dollars in HELOCs had not yet reached the end of their draw period and entered their pay down period as of the end of December 2013. These borrowers are potentially susceptible to “payment shock,” the firm said, since many of them would have been making interest-only payments during the draw period of their HELOCs and may not be prepared for the sometimes 60% increased payment amounts once the pay down period starts.
The NCUA joined with other financial regulators to draw attention to this risk in early July.
“Home equity lines of credit were quite popular during the housing boom in the mid-2000s,” TransUnion's Steve Chaouki, head of financial services, said. “For many people, HELOCs represented a low-interest rate opportunity to borrow against the value of their homes, which were rapidly appreciating at the time. HELOCs generally had lower interest rates than credit cards or other loan types, and that interest was often tax-deductible.”
TransUnion's research found lenders originated nearly half of all HELOC balances at of the end of 2013 between 2005 and 2007. Many of these HELOCs had 10-year draw periods, and for those borrowers the draw period will come to an end over the next few years, TransUnion said.
“Some HELOC borrowers may not find this a problem,” explained Ezra Becker, vice president of research for TransUnion and co-author of a study the firm developed about the potential risk. “They may have the excess payment capacity to absorb the increase or they may have the equity in their homes to refinance the HELOC. But many borrowers won't have these and they are at risk.”
Becker explained the risk was not only in the possibility borrowers may default on their HELOC, but instead that borrowers may default on other loans in favor of making the HELOC payments.
“They may conclude that house prices are rising, I really want to protect my home so I will pay the HELOC and let the credit card go,” Becker said.
He also said TransUnion's research showed credit scores were good predictors of how a borrower would perform during the pay down period of a HELOC, particularly the enhanced scores that measure, for example, the size of a borrower's payments.
A borrower with a solid credit score who only makes minimum payments on credit accounts might be in poor position when a the HELOC starts its pay down period, Becker explained.
However, the challenge might also provide an opportunity, Becker pointed out. Credit unions may be well positioned to help refinance HELOCs, attracting new money from other institutions.
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