Before the market crashed in 2008, home equity lines of credit, or HELOCs, were all the rage. But times have indeed changed, and as the tab is now coming due and many HELOCs are nearing their end-of-draw period, the federal government wants to make sure that banks do not run into trouble trying to collect from customers whose stations may have changed for the worse.
On Wednesday, four federal financial regulatory agencies and the Conference of State Bank Supervisors [1] (CSBS) issued risk management guidelines [2] for financial institutions that need to be aware of the challenges borrowers may face in paying off their HELOCs.
While many borrowers will continue to meet their contractual obligations when their loan resets to an amortizing payment or reaches a balloon maturity, some may find it difficult to make higher payments or to refinance their existing loans due to changes in their financial circumstances or declines in property values.
According to the guidelines, financial institutions should be fully aware of end-of-draw conditions and stipulations, develop a clear picture of scheduled end-of-draw period exposures, and identify higher-risk segments of portfolios.
Management reports should also identify contractual draw-period transition dates for all HELOCs, showing maturity schedules that look at product types, post-draw payment characteristics, origination channels, and borrower characteristics. Managers should also evaluate near-term risks. Some HELOCs approaching their end-of- draw periods may already have line availability suspended due to decreased property values or repayment performance problems, for example.
The most proactive recommendation for lenders is to open the lines of communication with HELOC customers, preferably six months before individual end-of-draw periods kick in. Working with customers, managers can ensure that refinancing, renewal, and modification programs are consistent with regulations and still develop plans the borrower can handle.
The guidelines also recommend that lenders develop their own internal rules and processes for end-of-draw actions as well as alternatives. They should also establish end-of-draw reporting that tracks actions taken and subsequent performance. Part of this should involve offering practical information to higher-risk borrowers.
More than anything, the government and CSBS want to head off an alternative version of the mortgage crisis, in which products such as option adjustable-rate mortgages created a meltdown when the heftier terms kicked in and left many borrowers unable to meet their loan obligations.
"When borrowers experience financial difficulties," the guidelines stated, "financial institutions and borrowers generally find it beneficial to work together to avoid unnecessary defaults."