A new mortgage crisis, this one in home equity loans, could be brewing as payments are due to rise sharply for borrowers who took out such loans during the years of the housing bubble.

More than $221 billion in home equity loans are expected to reach the end of their interest-only phase over the next four years, according to a report from Rutgers, requiring borrowers to begin paying down principle on those loans as well. That represents some 40 percent of all outstanding home equity loans.

Many home equity loans, particularly home equity lines of credit, are interest-only for the first 10 years, meaning that this year borrowers must begin paying down the principle on loans they originated in 2003. An analysis cited from Fitch Ratings suggested that monthly payments could more than triple for a typical borrower who took out a home equity loan during the housing bubble years.

Delinquencies on home equity loans have nearly doubled this year, according to figures from Equifax, reaching 5.6 percent of all home equity loans originated in 2003, up from 3 percent for loans of the same vintage last year.

Rate resets may lurk

These borrowers could see their payments go even higher if interest rates rise, as is likely to happen once the Federal Reserve scales back its bond buying program. Home equity lines of credit (HELOCS) tend to be adjustable-rate loans subject to variations in mortgage rates, though they often convert to fixed-rate loans once the interest-only phase ends.

Borrowers who took out home equity loans during the bubble are more likely to still be upside-down on their mortgages, which makes it difficult or nearly impossible to refinance their home equity loans or roll them into their primary mortgage, both of which could lower their overall payments.

However, lenders may be willing to modify loan terms for such borrowers, particularly if large numbers of home equity loans begin to default. Home equity defaults are particularly costly for lenders, often resulting in a total loss, because in a foreclosure they are not paid off until the primary mortgage is satisfied in full. That gives home equity lenders a strong incentive to work with financially stressed borrowers to work out a manageable payment plan.

Published on November 26, 2013