Whenever a borrower is unable to make current debt-service obligations from current income, they have two choices: either declare bankruptcy, or use more debt to pay their debt service. Once a borrower starts using debt to pay debt, they’ve gone Ponzi.
During the housing bubble, many borrowers went Ponzi. It was characterized as a “sophisticated” method of managing personal finances. Since many homeowners came to view their house as another breadwinner, they believed this additional debt was income, and they treated it as such.
Now with the home ATM machine broken, perhaps permanently, many Ponzis are struggling to pay their bills. Many have already defaulted and lost their homes (as evidenced by my daily property profiles). Those that are hanging on have been struggling for six years now, and more and more of them are giving up and defaulting on their HELOCs.
One of the only types of debt with increasing delinquencies
By Jonnelle Marte — July 14, 2013, 7:54 a.m. EDT
Despite all the seemingly positive news surrounding the housing market and consumer credit this week, at least one subset of homeowners is still struggling: those with home equity lines of credit.
In 11 of the 13 loan categories tracked by the American Bankers Association — including car loans, personal loans and bank-issued credit cards — delinquency rates actually fell in the first quarter of this year, according to data released Tuesday. But delinquency rates rose in two categories. One of those was home-equity lines of credit, which saw delinquencies rise to 1.91%, from 1.85% the previous quarter (the other was mobile-home delinquencies, which increased slightly). The rise in delinquencies among home-equity lines “could continue on for a while,” says Keith Gumbinger, vice president of HSH.com, a mortgage information site.
There is nothing to be done to help Ponzis, and we shouldn’t try. Enabling this kind of behavior simply promotes more of it. Ponzis are parasites who used to live on the banker’s dime, but with the implied guarantee of too-big-to-fail, they are now parasites living on the US taxpayer. As more and more Ponzis implode, they default on their HELOCs. In their minds, once the home ATM machine stopped paying cash, there was no reason to keep feeding it.
Most home-equity lines, for instance, allow borrowers to make interest-only payments for the first few years of the loan. But after that period, borrowers have to start paying down the principal. Faced with a much higher monthly payment, many borrowers are becoming overwhelmed, says James Chessen, the ABA’s chief economist.
Remember the ARM reset issue? Housing bears postulated that the millions of borrowers who used interest-only and negatively-amortizing ARMs would implode when their payments reset and recast to higher payments. Those borrowers did default, and the banks warehoused them in shadow inventory (now cloud inventory), a purgatory where many of them live today.
Plus, some of those homeowners took out their home-equity lines of credit during the boom years, between 2003 and 2007, when property values were mostly rising, says Chessen. And with many of their mortgages underwater, or worth more than the sale price of their homes, many borrowers are unable to refinance, which would normally give them more time to make payments, he says.
More time to make payments? That is ultimately what the banks want. They don’t particularly want these people to retire their debt, they just want a few more payments out of them before they implode.
Adding to the pain is the fact that interest rates are starting to climb higher, which can potentially raise monthly payments for people with adjustable-rate mortgages.
Rising interest rates — which translates to higher borrowing costs — is what will push many of these Ponzis over the edge. During the housing bubble, they could serially refinance into every-falling interest rates and keep the payments manageable. Rising interest rates not only prevents them from obtaining more money and making lower payments, it causes them to make larger payments on the debt they already have.
To be sure, many banks are more willing to lend — including through home-equity lines of credit — as the job market improves and consumers become better at managing their debt, says Chessen.
Does “managing” their debt include paying it off and living without it? Only bankers and Ponzis think in terms of managing their debts.
But for the homeowners who are nearing the end of interest-only periods and are worried they won’t be able to afford the higher monthly payments, there may be ways to avoid falling behind.
Some borrowers may get a break from another lender if their bank isn’t able to refinance the loan, says Chessen. And they should approach their lenders as soon as they expect they might start to struggle with their payments, he says. “The sooner you talk to them, the more options you may have,” says Chessen.
Homeowners should be upfront with their lenders about any financial difficulties and ask the bank to restructure the loan in a way that might make the payments more manageable, says Gumbinger. Because banks often carry home-equity lines directly on their books and would need to coordinate with another lender to foreclose on a property—when mortgages and home equity lines are not issued by the same bank—they may be willing to help a borrower out, he says. “You are not necessarily in as weak a position as you think,” he says.
Banks with unsecured HELOCs are screwed, so of course they are willing to make deals. Any acknowledgment on the debtor’s part that they owe money will help the bank perfect their claim to the borrower’s assets if the debt gets detached from the property.
For instance, some lenders might be willing to delay the start of the payment period slightly, says Gumbinger. Borrowers who know they will be on better financial ground in six months to a year might be able to request an extension, he says.
Borrowers can also ask for a longer repayment period, extending the time over which the loan must be paid back from, say, 10 years to 15 years, which could lead to smaller monthly payments, he says. And some banks may also be willing to lower the interest rate on the loan, says Gumbinger. (Though not all loans allow for rates to be adjusted, he adds.)
And banks will be willing to amend, extend, pretend on HELOCs just as they have on delinquent first mortgages. The can kicking will continue until these borrowers are no longer underwater at which point the banks will become far less accommodating.
He simply couldn’t afford it
The former owner of today’s featured property paid $1,038,000 on 11/4/2005. He used a $778,500 first mortgage, a $155,700 HELOC, and a either a $259,500 or a $103,800 down payment depending on how much of the HELOC was used for purchase money. There were no further refinances.
The borrower defaulted in mid 2009, and he was allowed to squat for two years until the bank bought it on 4/15/2011. Whatever strength the high end of the market is exhibiting is an illusion created by withholding inventory like this property. It spent two years in lender inventory before they finally brought it to market this year.
How many more properties like this one are lenders withholding from the market?
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Proprietary OC Housing News home purchase analysis
2840 MADONNA Dr Fullerton, CA 92835
$719,900 …….. Asking Price
$1,038,000 ………. Purchase Price
11/4/2005 ………. Purchase Date
($318,100) ………. Gross Gain (Loss)
($57,592) ………… Commissions and Costs at 8%
($375,692) ………. Net Gain (Loss)
-30.6% ………. Gross Percent Change
-36.2% ………. Net Percent Change
-4.7% ………… Annual Appreciation
Cost of Home Ownership
$719,900 …….. Asking Price
$143,980 ………… 20% Down Conventional
4.52% …………. Mortgage Interest Rate
30 ……………… Number of Years
$575,920 …….. Mortgage
$143,181 ………. Income Requirement
$2,925 ………… Monthly Mortgage Payment
$624 ………… Property Tax at 1.04%
$0 ………… Mello Roos & Special Taxes
$150 ………… Homeowners Insurance at 0.25%
$0 ………… Private Mortgage Insurance
$0 ………… Homeowners Association Fees
$3,699 ………. Monthly Cash Outlays
($698) ………. Tax Savings
($756) ………. Principal Amortization
$242 ………….. Opportunity Cost of Down Payment
$200 ………….. Maintenance and Replacement Reserves
$2,687 ………. Monthly Cost of Ownership
Cash Acquisition Demands
$8,699 ………… Furnishing and Move-In Costs at 1% + $1,500
$8,699 ………… Closing Costs at 1% + $1,500
$5,759 ………… Interest Points at 1%
$143,980 ………… Down Payment
$167,137 ………. Total Cash Costs
$41,100 ………. Emergency Cash Reserves
$208,237 ………. Total Savings Needed