By Jennifer Yousfi
Managing Editor
With default rates rapidly increasing, credit standards for home equity loans and revolving home equity lines of credits (HELOCs) have tightened, cutting off what was once a reliable source of capital for homeowners.
Following the lead for first mortgage guidelines, lenders are tightening credit standards for home equity loans and lines of credit in the past few months. In the past, the biggest consideration for lenders was the amount of equity in the home, but with mortgage default rates soaring, lenders are requiring higher credits scores and lowering the amount of equity available to borrow against.
A traditional home equity loan, or second mortgage as they are often called, has a set time period and repayment schedule, often at a fixed rate. But HELOCs can be open-ended, allowing homeowners to only take out what they need and then borrow again after repayment.
"You have basically a looming threat of a recession and the probability that unemployment rates are going to rise. That's going to cause banks to be more cautious," Keith Leggett, senior economist with the American Bankers Association, told MarketWatch.
The weakening U.S. economy has had both positive and negative effects on home equity products. Adjustable rate loans have lowered as the prime rate [tied to the Federal Reserves benchmark rate] has been slashed. But the decrease in housing prices has meant a subsequent decrease in the amount of equity available to homeowners. [For another story in this issue that addresses how the decrease in housing prices is affecting municipal bonds, please click here.]
Countrywide Financial Corp. (CFC) is the nation's largest home equity product lender with a 9% market share. The California-based lender was forced to take a $704 million charge against its $32.4 billion prime HELOC portfolio in the recent quarter due to defaults, Fortune reported.
The trend is particularly troubling as home equity products have always been riskier than first mortgages.
"That's because the first lien takes priority, so if a borrower defaults, the second mortgage gets paid off after the first mortgage does," Pam Hamrick, vice president of LendingTree Loans told MarketWatch. "And with foreclosure volumes breaking records lately, lenders are concerned that first-lien loans will be paid back let alone home-equity lines."
Equally troubling for investors, it is often difficult to gauge the size of a lender's home equity portfolio. The assets are often carried off balance sheet until there's a problem as shown by Countrywide. If the home equity defaults persist, the banking industry could be in for yet another round of write-downs.
Related News and Story Links:
- Fortune:
Home equity loan defaults soar
- MarketWatch:
Lower confidence greets lower rates