By: Lance T. Denha
For those in the mortgage and banking industry, there is a growing cause for concern that the real estate market could be heading toward a new financial crisis with respect to home equity credit lines. Many are worried that since there were billions of dollars in home equity credit lines extended a decade ago, there is the potential for a new wave of defaults for banks and homeowners.
Home Equity Credit lines, in essence, are second mortgages with floating rates and flexible withdrawal terms. Home equity financing can be set up as a loan or as a line of credit. In contrast, a home equity loan is a loan in which the lender advances homeowners the loan amount upfront, while a home equity credit line provides a source of funds that you can draw on as needed.
According to an LA Times Article, Home equity credit lines carry mandatory “resets” requiring borrowers to begin paying both principal and interest on their balances after 10 years. During the initial 10-year draw period, only interest payments are required. The difference between the interest-only and reset payments on these credit lines can be substantial- $500 to $600 or more per month in some cases. If borrowers cannot afford or choose not to make the fully amortizing payments that reduce the principal debt, the bank that owns the note can demand full payment and foreclose on the house if there is sufficient equity.
Also according to federal financial regulators, about $30 billion in home equity lines dating to 2004 are due for resets next year, $53 billion the following year and a staggering $111 billion in 2018. However refinancing often will not be possible because the homeowners won’t qualify under the tougher mortgage rules taking effect in January, or the combined first and second mortgages may exceed the value of the house.
Also according to the article, financial regulators are aware of the potentially high volume in high-risk resets and have been urging the biggest banks to set aside extra reserves for possible losses.
It is highly advisable for all homeowners to become proactive and check their credit line documents to determine the date of reset as well as to contact the bank and ask for an estimate of what the post-reset payment could amount to at the current principal balance.
Most important, be aware of your options. Since lenders are being pressured by regulators to deal with their potential equity loan issues in advance, you might be able to come up with a modification solution acceptable to both you and the bank. It is advisable to speak with a legal professional regarding your options.