Home Equity Loans Join the Ranks of Subprimes

Household budgets are currently strained, and many homeowners are falling behind on payments. The American Bankers Association reports that home equity loan defaults are rising. It seems that all kinds of loans may go the way of notorious subprime mortgages.

Most experts recommend that home equity loans be used sparingly, and used only to fund expenses such as home makeovers or repairs that contribute to the intrinsic value of a property. But during the past several years, home equity rose at breakneck speed as it followed the spiking trend in real estate prices.

As it did, homeowners tapped into it and used the new windfall to pay for all sorts of things that had no relationship to enhancing their underlying home equity. Wise advice to conserve equity was ignored, or considered old-fashioned, outmoded, and irrelevant. But now that home prices have plummeted, lenders are seeing a new surge in defaults and delinquencies related to home equity loans. The percentage of home equity lines of credit (HELOCs) that are past due is the highest it's been in more than a decade. As inflation continues to plague the average American household, lenders anticipate that the volume of home equity loan delinquencies and subsequent defaults will continue to grow.

Cutting back on home equity loans

When the market for subprimes became treacherous for lenders, they reacted by essentially discontinuing most of their subprime products. During the first half of this year, bankers curtailed home equity lending, although they still offered many second mortgage products. Rather than eliminate them altogether, most lenders have made them harder to qualify for, while simultaneously revoking or shrinking the limits on previously extended lines of credit. Many borrowers, for example, enjoyed HELOC loans last year; but this year, they received notification letters informing them that those lines of credit had been suspended. Hundreds of thousands of consumers had their credit privileges denied or diminished during the springtime of 2008-and that was before the default rate began to rise and turn into an avalanche of bad loans.

While the situation is reminiscent of the scenario that unfolded a year or two ago when the subprime market began to erode, this time, one significant difference exists. Lenders have learned from the subprime crisis, and they're not waiting around for the next shoe to drop. Instead, they're taking aggressive steps to limit their losses. This translates into fewer home equity loan opportunities for the American consumer.

Staying above water

Those who are falling behind on HELOCs and other home equity loans should do their best to catch up and try to pay off any second mortgages, because outstanding equity loans make it harder to refinance primary mortgages. Those unable to refinance an expensive first mortgage because of a relatively small, but outstanding, home equity loan, may get stuck with both. It's those kinds of problems that are pushing people over the brink and into serious financial trouble.