Why Isn't Anyone Defaulting on HELOCs?

Delinquency rates on home equity lines of credit, commonly known as HELOCs, have significantly declined since the beginning of the Great Recession, particularly compared to the delinquency rates of traditional mortgages. Why are these loans seemingly more immune from the housing crash? The answers provide some interesting insights into the current state of certain segments of the housing market and the economy in general.

According to Experian-Oliver Wyman Market Intelligence reports, a quarterly analysis of consumer credit trends, the total percentage of balances in delinquency was at or under 1% in the second quarter of the year for the three delinquency states measured: 30 to 59 days delinquent, 60 to 89 days delinquent and 90 to 180 days delinquent. That’s an astoundingly low delinquency rate on these lines of credit, even though HELOCs traditionally have low delinquency rates. In fact, these are the lowest delinquency rates as a percentage of balances since roughly mid-2007.

Alan Ikemura, Senior Product Manager of Experian Decision Sciences, says the findings are evidence of a larger trend of declining delinquencies for other loan products as well.

“We’re improving across the board on consumer behavior,” he says.

So why are HELOCs in particular only pulling 1% delinquencies while mortgage delinquency rates as a percent of total balances are almost double that? It comes down to the type of consumers that are taking out home equity lines of credit.

“Nearly 90% of second quarter HELOC originations are going to A & B — super-prime and prime — consumers,” Ikemura says.

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While lending has been tight across the board, Ikemura says HELOCs in particular are considered pretty conservative loan types, which means that lenders require a borrower with very good credit for the loan.

Another reason that HELOC delinquencies are so low could also be attributed to the fact that fewer HELOCs are being originated now than pre-recession due to lower home values. With many homeowners underwater on their mortgages, there’s no home equity to back a line of credit, so a HELOC simply is not an option to many Americans. As homes prices rise, however, more homeowners could regain equity in their home and find HELOCs a good option once again, according to Ikemura.

Bill Westrom has worked closely with HELOCs in his 16 years as a mortgage broker, as well as in his role as the co-founder and CEO of TruthInEquity.com, an organization that advises consumers on how to use equity to manage debt. Westrom says there is also a misconception among homeowners that they don’t have the equity to qualify, when they actually might.

“People just don’t know what their home is worth,” he says. “And most people assume it’s pretty low. Sometimes they’ll make a guess or go off an appraisal from three years ago.”

Westrom also notes that that HELOCs are generally interest-only loans, which means smaller, more affordable payments. This, he says, could also contribute to low HELOC delinquency rates.

Borrowers should understand the risks of a HELOC, however. A home equity line of credit can result in a foreclosure, just like a mortgage can, Westrom explains.

Down the road, HELOC delinquency rates could rise again as lending standards open up, more banks decide to lend and more homeowners decide to pursue a HELOC.

“As home values rise and equity is established again in households, we could see a pickup in HELOC originations,” Ikemura says.

Westrom says a key sign that lenders are opening up HELOCs to more borrowers will be marketing. A credit union he used to work with once marketed HELOCs as a way to pull some equity out of your home in order to buy a TV. That kind of marketing is just not happening these days.

“It used to be all about consumption,” Westrom says. “Banks aren’t giving customers a reason to come in and ask for one yet.”

Image: meddygarnet, via Flickr