Banks Warned to Prepare for Wave of HELOC Defaults

July 3, 2014

Federal regulators are warning banks that home equity lines of credit taken during the housing bubble will come due in the next several years, which could cause a surge of defaulters. The regulators are pressing banks to be proactive in helping clients avoid defaults, or banks may risk losing hundreds of billions of dollars.

More than $221 billion HELOCs at the nation’s largest banks are reaching the 10-year mark within the next four years. At that point, borrowers must start paying down the principal loan as well as the interest. The number of borrowers who miss payments can double in the eleventh year, according to data from Equifax, a consumer credit agency. So federal regulators are urging banks to help borrowers before it’s too late.

“When borrowers experience financial difficulties, financial institutions and borrowers generally find it beneficial to work together to avoid unnecessary defaults,” according to a statement issued by five federal regulators, including the Office of the Comptroller of the Currency, the Federal Reserve, the Federal Deposit Insurance Corp., the National Credit Union Administration, and the Conference of State Bank Supervisors. The agencies have released a plan for how banks could oversee their HELOC portfolios as they near the timeline and how to work with clients who may be unable to pay.

Banks stand to lose 90 cents on a dollar when a HELOC defaults since the line of credit is generally a second mortgage. If the property is foreclosed upon, most of the sale’s proceeds go to pay off the first mortgage, leaving the home equity lender with little left over, if any.

“If economic growth picks up, and home prices rise, borrowers may be able to refinance their main mortgage and their HELOC as a single new fixed-rate loan,” Reuters reports. However, regulators caution banks to take steps to minimize the risk.

Source: “U.S. Regulators Warn Banks on Home Equity Loan Defaults,” Reuters (July 1, 2014)