HELOC abusers and lenders face day of recast reckoning
Home equity lines of credit (HELOCs) were the favored tools of Ponzis during the housing bubble. These were used like a credit card with an ever-expanding credit balance that didn’t need to be paid back because the house was paying for it. Most borrowers viewed this as truly free money, and they behaved accordingly. This influx of spending drove the economy during the first half of the 00s, and the elimination of this stimulus and the subsequent need to repay this debt is what’s causing our economic doldrums today.
HELOCs are similar to other revolving lines of credit with a few key differences. HELOCs are secured by real estate whereas a credit card is not. If a borrower does not repay a HELOC, the lender can foreclose on the house to force repayment. A credit card is not similarly secured. HELOCs have a minimum payment like a credit card, but the payment is interest-only each month. No principal payment is required — at least at first. After an initial period, the HELOC can no longer be increased, and the balance must amortize to zero over a set period of time similar to a conventional mortgage. In this regard HELOCs are very similar to interest-only ARMs and Option ARMs which proliferated during the housing bubble and created the dreaded ARM recast problem.
Many housing market watchers concluded the wave of ARM resets and recasts would cause millions of defaults and foreclosures. They were half right. These loans did reset, but the interest rates were lower, so that caused little payment shock; however, these loans also recast from interest-only and negative amortization to fully amortizing causing a huge payment shock. The majority of the borrowers who used these loans did default, but these defaults did not lead to an expected wave of foreclosures because lenders chose to allow these borrowers to squat in shadow inventory without making any payments. In short, the payment shock from recasting loans was extreme, it did cause defaults, and these properties are yet to be recycled through the system.
The same issue is facing HELOCs.
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Proprietary Irvine Housing News home purchase analysis
$475,000 …….. Asking Price
$530,000 ………. Purchase Price
7/25/2008 ………. Purchase Date
($55,000) ………. Gross Gain (Loss)
($42,400) ………… Commissions and Costs at 8%
============================================
($97,400) ………. Net Gain (Loss)
============================================
-10.4% ………. Gross Percent Change
-18.4% ………. Net Percent Change
-2.7% ………… Annual Appreciation
Cost of Home Ownership
——————————————————————————
$475,000 …….. Asking Price
$16,625 ………… 3.5% Down FHA Financing
3.55% …………. Mortgage Interest Rate
30 ……………… Number of Years
$458,375 …….. Mortgage
$127,510 ………. Income Requirement
$2,071 ………… Monthly Mortgage Payment
$412 ………… Property Tax at 1.04%
$0 ………… Mello Roos & Special Taxes
$119 ………… Homeowners Insurance at 0.3%
$477 ………… Private Mortgage Insurance
$215 ………… Homeowners Association Fees
============================================
$3,294 ………. Monthly Cash Outlays
($309) ………. Tax Savings
($715) ………. Equity Hidden in Payment
$19 ………….. Lost Income to Down Payment
$79 ………….. Maintenance and Replacement Reserves
============================================
$2,368 ………. Monthly Cost of Ownership
Cash Acquisition Demands
——————————————————————————
$6,250 ………… Furnishing and Move In at 1% + $1,500
$6,250 ………… Closing Costs at 1% + $1,500
$4,584 ………… Interest Points
$16,625 ………… Down Payment
============================================
$33,709 ………. Total Cash Costs
$36,200 ………. Emergency Cash Reserves
============================================
$69,909 ………. Total Savings Needed
The property above is available for sale on the MLS.
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Cost of Ownership Analysis
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