Home Equity Loans the Next Train Wreck

Creditors now fear that homeowners, crushed beneath $1.1 trillion in home equity debt, could find it difficult to pay what they owe.

For the first time, many home values are down below 50 percent of their market price minus their mortgage debt, and banks are understandably nervous.

This means that while U.S. home ownership spiked to unprecedented levels earlier in the new century, too many owners with home equity debt now only have a half-interest or less in their devalued homes.

Add to that gloomy fact the rising rate of home equity loan delinquencies and defaults — 5.7 percent in December, up from 4.5 percent a year earlier, according to Moody's Economy.com —and there's a potential new calamity in the making. Lenders can see it coming, and to make sure they get their money, banks have been moving to block home sales or mortgage refinancing until home equity debtors pay all or part of their outstanding debt, playing hardball with home equity debtors.

For example, in some cases under lending terms homeowners unable to sell their residence may not put it up for rent.

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Still, there's not much that banks with shaky home equity loans on their books can do. In the event of missed payments or defaults, lenders with first mortgages get paid first and paid in full.

If there's anything left, home equity creditors get paid next; not a favorable position to be in when so many home equity debtors are over-extended and home values are continuing their downward spiral. Among the states where home values have dropped the most are Arizona, California, Florida and Nevada. These were among the states where home ownership boomed in the easy years, and an ever-upward real estate market encouraged home equity borrowing.

In California, for example, housing prices are down on average 17 percent in Orange County, Los Angeles and the San Diego metro areas. Reports from California realtors cite as much as a 26 percent drop in certain areas.

Overall, housing sales are at their lowest in 13 years, and pessimists among the experts are predicting an even steeper decline before the hoped-for bounce back.

And yet, home equity lines of credit are still being vigorously marketed by lenders, with rates ranging from 4.24 percent APR to 7.35 percent – some rates fixed, some variable – plus fees.

But the loans are made only to borrowers whom the banks certify as credit worthy.

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