The Wall Street Journal-20080116-Lenders Rethink Home-Equity Loans- As Delinquencies Rise- Some Companies Are Walking Away Instead of Foreclosing- While Others Get Stingy With Borrowers
Return to: The_Wall_Street_Journal-20080116
Lenders Rethink Home-Equity Loans; As Delinquencies Rise, Some Companies Are Walking Away Instead of Foreclosing, While Others Get Stingy With Borrowers
Rising delinquencies and falling home prices are putting home-equity lenders and borrowers in a tightening bind.
As home values continue to sink, mortgage companies are increasingly walking away from delinquent home-equity loans rather than pushing borrowers into foreclosure. At the same time, some lenders, in an effort to protect against future losses, are looking at scaling back home-equity lines of credit held by certain borrowers who are still making payments.
Mortgage companies typically begin sending foreclosure notices when a borrower is more than 90 days behind on payments and can't come up with a plan to resolve the problem. But in many cases, the companies have concluded that they are better off not foreclosing on borrowers who can't make payments on their home-equity loans and other types of second mortgages.
"More often now than ever before we are writing off the loan" when borrowers fall behind on home-equity payments, says Bob Caruso, Bank of America Corp.'s national servicing executive. "The customer still owes the money, but it is no longer an asset on our books." That doesn't let the borrower off the hook: The lender keeps the lien in place, however, in the hopes that it will receive some money when the property is sold.
This approach can make it less likely that borrowers will lose their homes if they can't make their second-mortgage payments. But it can also complicate efforts to work out a resolution to the borrower's loan problems -- and the borrower may still have to contend with the loan down the road, such as when he refinances or sells the property, for example.
Home-equity lending exploded during the housing boom as homeowners took advantage of rising home values and tapped their equity to fund spending. Others flocked to so-called piggyback loans, which allowed them to finance as much as 100% of a home's value by combining a mortgage with a home-equity loan.
With home values falling, lenders began last year to cut back on originations of new home-equity loans. Lenders extended an estimated $456 billion of new home-equity loans and lines of credit in 2007, down from a peak of $504 billion in 2006, according to SMR Research in Hackettstown, N.J.
The dollar value of home-equity loans outstanding stood at $1.1 trillion in the third quarter of 2007, according to the Federal Reserve.
Most borrowers continue to make their home-equity payments. But delinquencies are climbing. Some 4.65% of fixed-rate home-equity loans were delinquent in the fourth quarter of 2007, up from 3.11% a year earlier, according to Equifax and Moody's Economy.com. Delinquencies on home-equity lines of credit nearly doubled, to 2.01% from 1.07%, during this period. "The loss rates are climbing at all lenders," says Frederick Cannon, an analyst at Keefe, Bruyette & Woods.
Moody's Economy.com estimates that losses on home-equity loans outstanding as of June 30, 2007, could ultimately total $58 billion -- on top of $278 billion in losses on mortgages.
When companies write off these loans, it reflects the grim economic realities facing lenders and investors who own home-equity loans. To foreclose, the holder of the home-equity loan must buy out the owner of the first mortgage. But when home prices fall, the property's value often isn't enough to cover the first mortgage, any past-due interest or fees, and the costs associated with foreclosure. That means in situations where there is a first mortgage, the holder of the home- equity loan can actually wind up deeper in the red by foreclosing.
"You can make a horrible decision by choosing to foreclose," says Steve Bailey, a senior managing director with Countrywide Financial Corp. It "can be a worse decision than doing nothing."
But such moves can complicate efforts to resolve borrowers' problems. "The seconds don't have any incentive to resolve anything," says Babette Heimbuch, chief executive of FirstFed Financial Corp., based in Santa Monica, Calif., which makes loans through its banking subsidiary. "It's very frustrating."
In addition to walking away from delinquent loans, some banks are hoping to stave off future problems by reducing the amount of credit available to certain borrowers with lines of credit. Washington Mutual Inc. late last month notified about 3,200 of its customers with home- equity lines of credit that it was reducing the maximum amount they could borrow. The borrowers "have experienced an adverse change in their financial situation, as evidenced by a substantial credit-score reduction," a company memo said.
The memo added that in January, additional reviews would "result in additional decreases for borrowers with recently declining credit scores, as well as those with additional risk factors," such as declining home values.
A Washington Mutual spokeswoman says the action "was taken as part of our normal course of business" and that the company has "programs that have been in place for years that increase, decrease, block and suspend lines of credit based on a number of factors," including the borrower's payment status, credit history and property value.
Citigroup Inc.'s Citibank unit says that under the borrower's credit agreement, it is permitted to freeze home-equity advances or reduce credit limits if the home's value has declined below the original appraisal, or if it reasonably believes the borrower won't be able to make the required payment. Such adjustments are increasing in the current market environment, a company spokesman says. David Stevens, who runs the mortgage operation at Long & Foster Real Estate, based in Fairfax, Va., says he's received several calls from borrowers whose home-equity lines have been reduced because of falling property values. "It's a very prudent move, given the circumstances in the market today."
USAA Federal Savings Bank recently told one customer it was suspending his ability to borrow on his home-equity line after a review showed that the value of his home had declined since the line was originated and because of information on his credit report. "As with many other creditors, we are reviewing all home-equity lines of credit to ensure our credit exposure is commensurate with current market conditions and taking action where necessary," the bank said in a letter sent to the borrower. A USAA spokesman says he can't comment on the specific situation without more information, but adds that such reviews are done on a "case-by-case basis."
Such moves could become more common down the road. Wachovia Corp. doesn't currently make such adjustments, but "there is a reasonable probability" that it could do so in the future "based on what we're seeing in the marketplace," says Walter Davis, head of retail credit.
National City Corp. says it is closely monitoring the housing market and its credit portfolio, and may reduce the credit lines of some borrowers on a "case-by-case basis" in markets where home values have declined, a spokeswoman says.
In some cases, servicers are telling borrowers they will take 10 cents on the dollar to settle their claim, says Micheal Thompson, director of the Iowa Mediation Service, which runs a hotline for homeowners in financial distress. In other cases, they are selling these loans at large discounts to third parties, says Kathleen Tillwitz, a senior vice president at DBRS, a ratings agency.
Coming up with a plan that will get borrowers back on track is easiest if both the mortgage and home-equity loan are held by the same party. Countrywide will sometimes "whittle down" the payment on the second mortgage to come up with an amount that the borrower can afford to pay for both mortgages, or even eliminate that payment, Mr. Bailey says. The company doesn't publicize such efforts, he adds, because that might encourage "people not to make their payment and see what happens." In either case, "the borrower still owes the principal," Mr. Bailey says.
Solutions can be harder to come by when the two loans were made by different lenders and are held by different parties. "The people in the first position will say, 'Until you get a deal with the second, why should I make a deal with you?'" says Iowa's Mr. Thompson. Second- mortgage holders are often reluctant to approve a short sale or deed in lieu of foreclosure that could wipe out their claims, he adds.
FirstFed says it encourages borrowers in financial distress to contact the owner of their home-equity loan and sometimes offers to buy out a home-equity loan with no current value for a small sum -- $2,000, for example -- so that the entire mortgage can be restructured.
But the company says such offers are often rejected. "It's not worth their while to take the $2,000" because of the costs associated with evaluating the offer and releasing the borrower from the lien, says Ms. Heimbuch, the company's CEO. "The second forces you into foreclosure."
