“If you are underwater on your mortgage — more than 1 out of 7 owners continues to owe more on the mortgage than the home is worth, according to realty data firm CoreLogic — and you can’t afford the reset payment, the bank may not foreclose on you because there’s no equity to recover. But the bank could sell your charged-off account to a debt collection firm or even pursue you for a deficiency judgment in states where that is permitted.”
Home equity lines due for reset may be looming financial disaster
Some borrowers may no longer be able to afford these credit lines when they are required to begin paying both principal and interest on their balances.
WASHINGTON — Could the real estate market be heading for a new financial storm? Maybe.
Some mortgage and credit experts worry that billions of dollars of home equity credit lines that were extended a decade ago during the housing boom could be heading for big trouble soon, creating a new wave of defaults for banks and homeowners.
That’s because these credit lines, which are second mortgages with floating rates and flexible withdrawal terms, 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.
But 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.
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. Amy Crews Cutts, chief economist for Equifax, one of the three national credit bureaus, calls this a looming “wave of disaster” because large numbers of borrowers will be unable to handle the higher payments. This will force banks to either foreclose, refinance the borrower or modify their loans.
But refinancings often will not be possible, Cutts says, 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. Complicating matters further, interest rates are likely to rise from their current low levels as the Federal Reserve tapers its purchases of Treasury and mortgage-backed securities. Higher base rates would make the payment shocks even worse. Plus, according to Cutts, many of the owners with high-balance credit lines already have low credit scores — legacies of the housing bust and recession — and have an elevated statistical risk of default after the reset.