As the mortgage market prepares for bubble-vintage home equity lines of credit (HELOCs) to come out of their draw period, multiple firms have issued warnings about the imminent wave of new HELOC problems. In a new blog post, however, CoreLogic deputy chief economist Sam Khater says the impact from HELOC loan resets will be more like a ripple.
Looking back to the inflation of the housing bubble in the mid-2000s, Khater notes that the surge in mortgage debt leading up the crash came partly from a surge in borrowers taking out HELOCs as home prices ran up.
Many of those lines were originated as 10-year interest-only loans, meaning millions of borrowers are due to for a possible payment shock as their HELOCs switch to fully amortizing loans at a time when the economy is still staggering to normalcy. Including the period from 2004–2006 when the majority of HELOCs were originated, an estimated $190 billion in loans are scheduled to reset in the coming years.
While many market watchers—including financial regulators—are concerned about the risk of default, Khater says the fears of a HELOC-related mortgage crash are largely unfounded.
"While the spike in defaults at the 10-year mark certainly is an issue for those borrowers experiencing the reset, from a macro perspective the impact will not be a wave, but small ripples," he writes.
To support his claim, he points to four major factors he says will mitigate the impact of HELOC payment shocks:
- The size of the reset pool is relatively small. Looking at the entire $9.9 trillion mortgage market, $190 billion is a fairly minor segment.
- Nearly one-quarter of HELOCs are in the first-lien position, meaning there's no other associated debt.
- One of the major default triggers—negative equity—is improving. By CoreLogic's numbers, the negative equity share for first liens with a home equity loan is 22 percent, well below the 36 percent underwater rate four years ago, and that number continues to improve. Adjusting for first-lien position and negative equity, the HELOC exposure shrinks from $190 billion to $31 billion, Khater says.
- The other trigger—unemployment—is also looking better. At the same time, the unemployment rate was below 6 percent as of the government's October estimate, marking a vast improvement as payroll numbers see ongoing strength.
Despite his optimism, Khater does note that HELOCs haven't seen the same kind of regulation the rest of the mortgage market has adjusted to in the last year. Of note is the fact that the Consumer Financial Protection Bureau's ability-to-repay rule skipped over HELOCs in its restrictions on interest-only loans.
"This begs the question, why didn't policy makers include a provision for HELOCs given their role in driving up mortgage debt?" he writes. "A more sensible approach for HELOC products would be to provide incentives for fully amortizing loans that do not lead to payment shock down the road."