Borrowers who had been paying only interest on about $16 billion in revolving home equity loans due to amortize between 2015 and 2017 will see their payments rise by an average of roughly $360 a month—a 165% increase, according to Citi's second-quarter earnings report.
Under the terms of the loans, borrowers pay interest only for the first 10 years. For the next 10, borrowers pay principal as well as interest, which is typically variable, so payments would spike even higher if the Federal Reserve raises rates. The loans typically amortize over 20 years, rather than the 30-year amortization for most home loans.
Citi—and the banking industry—have thus far dodged predicted blow-up of the home equity line of credit loans. (For related reading, see: Choosing a Home-Equity Loan or Line of Credit.)
Weaker Loans Are Beginning to Reset
One factor, at least at Citi, may be that the revolving home equity loans that matured before 2015 tended to be stronger than the group that is amortizing between 2015 and 2017. Of the loans about to amortize, roughly $1.2 billion, or 11%, had combined loan to value ratio greater than 100% as of June 30, 2015, according to the second-quarter report.
North America Home Equity Lines of Credit Amortization – Citigroup
In billions of dollars as of June 30, 2015
Another factor, as reported in The Washington Post, may be that the industry has effectively alerted borrowers that resets are coming and given them a bevy of options, in a strengthening economy, to refinance or restructure the loans.That seems to be what Citi is counting on.
“Citi continues to monitor our HELOC reset risk closely and has taken additional actions to offset potential risk,” Mark Rodgers, director of Citi’s public affairs said in an e-mail statement to Investopedia. “These actions include the establishment of a borrower outreach program to provide reset risk education, the formation of a reset risk mitigation unit and a proactive program for contacting high-risk borrowers. We may defer the collection of interest on a portion of the principal until the end of the term, as we often do for standard mortgage modifications. We believe we are adequately and appropriately reserved and will continue to consider any potential impact in determining allowances for loan loss reserves.”
Still, the firm’s annual report says that for many of its borrowers options will be few. (For related reading, see: Home-Equity Loan vs. HELOC: The Difference.)
"Borrowers’ high loan-to-value positions, as well as the cost and availability of refinancing options, could limit borrowers’ ability to refinance their Revolving HELOCs (home equity lines of credit) as these loans begin to reset," according to Citi’s annual report. Citi itself is in the same boat, since there's a limited market for lenders to sell delinquent home equity loans, as well as fewer loan modification programs.
As a result, "Citi’s ability to reduce delinquencies or net credit losses in its home equity loan portfolio in Citi Holdings, whether pursuant to deterioration of the underlying credit performance of these loans, the reset of the Revolving HELOCs ... or otherwise, is more limited as compared to residential first mortgages," Citi said in its most recent quarterly filing.
Citi customers aren’t the only ones facing resets. While some analysts have backed off earlier predictions of a home equity line of credit blow-up, others insist the loans represent an imminent crisis. For example, “Trouble Ahead: Tidal Wave of HELOC Resets About to Hit,” HousingWire warned in April.
About 3.2 million home equity lines of credit with a total value of $158 billion are still open and have yet to reset between 2015 and 2018, according to Realty Trac. More than half those lines of credit, about 1.8 million, are on properties that are "seriously underwater," meaning the combined loan to value ratio of all outstanding loans secured by the property is 125% or higher.
Risk Snapshot for Other Banks
The three largest home equity line of credit lenders are Wells Fargo (WFC), Bank of America (BAC) and JPMorgan Chase (JPM), according to Fitch. At JPMorgan, borrowers had the option of paying 1% of the outstanding balance before the loans amortize or making interest-only payments based on a variable index, usually the prime lending rate.
JPMorgan expects about $14 billion of the loans to amortize, beginning in the remainder of 2015. The bank expects another $7 billion in the loans to be resolved either when borrowers pre-pay or the bank charges them off. "The firm manages the risk of HELOCs (home equity lines of credit) during their revolving period by closing or reducing the undrawn line to the extent permitted by law when borrowers are exhibiting a material deterioration in their credit risk profile," according to JPMorgan's June 30 quarterly report.
“Certain factors, such as future developments in both unemployment rates and home prices, could have a significant impact on the performance of these loans,” according to the report. At Bank of America, the total home equity line of credit portfolio has shrunk to $70.3 billion as of June 30, 2015, down from $74.2 billion as of Dec. 31, 2014. The bank attributes that, in part, to customers closing their accounts.
Wells Fargo announced in 2014 that it would overhaul the loans so new home equity lines of credit would no longer have an interest-only payment period. "The product should be designed to protect the consumer for the long term,” Brad Blackwell, a mortgage executive at Wells Fargo, told The Wall Street Journal. “We took this move not only because it’s the right thing to do for our customers, but because we’d like to lead the industry to a more responsible product.” He added, “We wanted to fix a flaw in the product that caused payments to go up sharply.” (For more, see: The Fuel That Fed the Subprime Meltdown.)
The Bottom Line
Citi has detailed its risks, but other banks may be just as vulnerable. An industry-wide wave of defaults on the total $158 billion home equity lines of credit that will reset through 2017 remains a real possibility.