Trend: Banks that avoided the subprime fallout face losses from home-equity loans based on homes now at risk.
Mara Der Hovanesian at BusinessWeek Magazine describes another offshoot of the subprime disaster. Excerpts below.
Disclosure: We currently own shares of UltraShort Financials (SKF).
Link: The Home Equity Crisis Ahead, BusinessWeek, Jan 16, 2008
Subprime mortgages have taken a lot of blame for banks' big losses. But there's another problem lurking behind the mess: home-equity lending.
Buoyed by rising prices, borrowers increasingly tapped into the equity on their properties to finance a new car, renovations, or even a down payment, making equity a key source of consumers' strength. But with the housing market in disarray and prices plunging, the business of home-equity lending is souring. At least $14.7 billion in loans and lines of credit were already delinquent through the end of September—the highest level in a decade.
A lender on a mortgage has the first claim on the underlying property. In the case of foreclosure, it can sell the property and recoup some money. The bank with the home-equity piece has no such collateral and is usually out the money.
Until recently, the preponderance of home-equity lending came in the form of lines of credit. They allowed borrowers to convert their equity into cash to pay down credit-card debt and the like. But as the boom raced on and housing prices soared to unimaginable heights, banks started offering second-lien, or piggyback, loans that buyers could use to finance their down payments. The practice allowed buyers, especially subprime ones, to buy ever-bigger houses they could ill afford. Traditional underwriting standards were thrown out the window, with buyers increasingly borrowing more than the value of their homes. As a result, this segment soared to 14.4% of the home-equity market in 2006, according to industry newsletter Inside Mortgage Finance.
The boom brought about some especially toxic home-equity loans. Homeowners gamed the system, steadily cashing out every bit of equity from their houses—a situation that arose in part because banks didn't track whether borrowers took out subsequent loans from competitors. Another bad practice: a home-equity loan on top of a payment-option adjustable-rate mortgage. Those ARMs allow borrowers to make monthly payments that amount to less than the interest. The principal keeps growing, eroding the equity, which makes it a risky home-equity loan on top of an already risky mortgage.
Comments