BLOG VIEW: Hit By HELOCs

In case any executives at firms that stayed away from subprime and have evaded major losses thus far have started to feel a little too comfortable, it seems there is officially a new reason to worry: Home-equity loans have become the latest product to post surging delinquency numbers and batter banks' balance sheets in significant numbers.

Notable names, including J.P. Morgan Chase & Co. and Wells Fargo & Co., are among the companies beginning to feel the pain from home equity loan-related losses, and no relief is in sight for 2008, writes Robin Sidel in the March 12 edition of the Wall Street Journal. J.P. Morgan is expected to report $450 million in losses in connection with home equity, with losses potentially reaching twice their current level by the end of 2008.

As with other finance products whose parties recently ended, in the case of home-equity loans, excesses and deviation from original purpose are likely the root of the trouble.

‘This product was meant to help people do construction on their house [and] do debt consolidation – not to take out every last dollar of equity in their home to finance a different kind of lifestyle,’ Charles Scharf, head of J.P. Morgan's retail business, told the Wall Street Journal.

That message was apparently lost on many consumers and lenders alike in home-equity loans' glory days, even as acknowledged delinquency concerns began to emerge over a year ago. Home equity lines of credit (HELOCs) enjoyed an especially active run.

Way back in February 2007, a prophetic Ray Morris, director of sales and marketing at GMAC Subservicing, noted the potential for trouble up the road: ‘There's been a lot of concern that the delinquency you're seeing on the first mortgage side is going to creep into the second mortgage side and the HELOC side,’ he commented at a Mortgage Bankers Association conference panel session.

As homes' values had already begun their free fall, Morris' 2007 anxieties were echoed by numerous other executives. Nevertheless, the product was wildly popular at the time – and even frequently marketed specifically to borrowers with shaky credit and dubious ability to honor their obligations on even their first mortgages.

Now that the repercussions have begun, pressing questions about the responsible lending practices and consumers' personal accountability – or, rather, the disconcerting collapse of either or both – abound:

‘The bankers knew exactly what they were doing from the get-go,’ insists a poster who calls himself GaryD, in response to a discussion entitled ‘Killer HELOCs’ on the housing blog Seeking Alpha.

On the other hand, ‘Who had a gun to the homeowner's head making them take the HELOC?’ responds a commenter identified as Parkite.

Regardless of who is more to blame for these latest delinquency troubles, the unfortunate reality remains that any distress with home equity loans or HELOCs is, of course, compounded by the loans' inferior positioning in the mortgage priority chain.

‘While banks can foreclose on a first-lien mortgage, lenders often have little recourse when trying to collect a delinquent home-equity loan, especially if another bank holds the primary mortgage,’ Sidel's article notes. ‘When another bank holds the mortgage and the mortgage payments are current, the home-equity lender is effectively powerless to collect the debt.’

But even in the wake of the latest news of home-equity loans' losses, none of that appears to matter to loan consultant Sarah Dinkins, who extols the virtues of Bad Credit [capitalization hers] HELOCs in an exuberantly worded (and questionably punctuated) piece published March 5 in the L.A. Chronicle.

With this wonder loan, ‘You have a minimum payment usually composed only of interests and a small portion of the capital and other than that you can repay as much as you want, as many times as you want and if you have some need you can withdraw money again from your line of credit,’ she explains. Sound appealing?

‘If you have what it takes to qualify, go ahead and replace your expensive credit card debt with a Bad Credit HELOC and start saving,’ Dinkins urges. Somewhere, an analyst at J.P. Morgan is grimacing.

– Jessica Lillian, Commercial Mortgage Insight

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