In July, the Office of the Comptroller of the Currency (OCC) issued a report warning mortgage servicers to prepare for the resetting of millions of home equity lines of credit (HELOCs), out of concern that a high percentage of borrowers could end up defaulting on these loans once the higher interest rates become effective.
‘Mortgage borrowers may face challenges as [HELOCs] near their end-of-draw periods,’ OCC officials wrote in their bulletin dated July 1. ‘As HELOCs transition from their draw periods to full repayment â�¦ some borrowers â�¦ may have difficulty meeting higher payments resulting from principal amortization or interest rate reset, or renewing existing loans due to changes in their financial circumstances or declines in property values.’
As the report points out, many of these borrowers got locked into their current HELOC deals just before the recession hit – but many will be facing interest rate resets over the next several years. Up until now, many of these borrowers have been making interest only payments – but as they enter the repayment period, ‘the outstanding principal is either due immediately in a balloon payment or is repaid over the remaining loan term through higher monthly payments, resulting in payment shock.’
The bulletin goes on to state that as these HELOC draw periods approach expiration, servicers ‘should communicate clearly and effectively with borrowers and prudently manage exposures in a disciplined manner.’ Central to this is establishing outreach programs to notify borrowers of pending resets as well as working with borrowers to arrive at workouts that are based on ‘prudent underwriting.’
‘Prior to extending draw periods, modifying notes, and establishing amortization terms for existing balances, lenders should conduct a thorough evaluation of the borrower's willingness and ability to repay the loan,’ the OCC bulletin states.
This week, Black Knight Financial Services issued a report showing that at least 2.5 million HELOCs will face resets over the next several years, resulting in an average increase of $250 per borrower monthly payment.
Based on current balances as well as the possibility of additional draws on HELOCs over the next year or so, it is fully expected that a high number of borrowers will face ‘payment shock’ and could end up in default as a result of these resets.
According to Kostya Gradushy, Black Knight's manager of research and analytics, the $250 average per month increase is based on current HELOC balances. However, as Gradushy explains, many borrowers still have time to take action – plus the payment increases are subject to change based on interest rates, home prices and other market factors.
‘Currently, borrowers whose HELOCs will reset over the next three years are utilizing just under 60 percent of their available credit,’ Gradushy explains. ‘Further draws on these lines – for those that have not been locked – could result in 'payment shock' after they are reset that is even higher than the national average of $250 per month.
‘Looking further down the road, HELOCs not likely to reset until 2019 are exhibiting even lower utilization ratios – about 40 peercent of available credit,’ Gradushy adds. ‘Upon reset, those borrowers are currently facing average monthly increases of $200. Should their drawing pattern match that of older vintages, we could be looking at a significantly higher risk of 'payment shock' for this segment.’
Adding to the problem is the fact that more distressed borrowers than ever are trying to ride out the storm and remain in their current homes, due primarily to the fact that they recently refinanced or received a mortgage modification. In addition, many of these borrowers will not be inclined to sell, due to the fact that they are ‘underwater’ and waiting to see if home values rise further.
‘We also looked at current levels of banks' home retention activity and, while the volume of modifications, trial modifications and payment plans has declined along with delinquencies and foreclosures, we found retention activity is still high relative to current levels of distressed loan inventory,’ Gradushy says. ‘On a state-by-state basis, home retention activity does not always correlate with the amount of distressed inventory. Such activity is much higher, for example, in California – where nearly 12 percent of distressed loans were the focus of some form of retention efforts – than in any of the other states in the top five ranked by distressed inventory.
‘In contrast, in the other four states in the top five – Florida, New York, New Jersey and Illinois – just over six percent of loans on average saw home retention actions,’ Gradushy adds.
Still, as the report shows, ‘new problem’ loans (loans that only recently entered default for the first time) are now at their lowest level – roughly 0.6% of all loans – and ‘roll rates’ (the number of loans that shift from current into progressively more delinquent statuses) have been improving over the long term across all categories. This means that the approaching ‘HELOC default storm’ may not be as bad as anticipated.
Meanwhile, in other data, Black Knight's report shows that the total U.S. loan delinquency rate reached 5.64% of all loans in July, a decrease of 1.13% compared to June.
What's more, the total U.S. foreclosure presale inventory rate reached 1.85% of all homes with a mortgage, a drop of 1.65% compared to June.
States with highest percentage of delinquent (30-plus days overdue) loans in July included Mississippi, New Jersey, Florida, Louisiana and New York.
States with the lowest percentage of delinquent loans included Arkansas, Montana, Colorado, South Dakota and North Dakota.
States with the highest percentage of seriously delinquent (90-plus days overdue) loans included Mississippi, Alabama, Rhode Island, Massachusetts and Louisiana.
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