Latest Bank Headache: Home Equity Loans

"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 (JPM) retail business.

That is, in a short phrase, the reason that the U.S. consumer is all spent out. They used debt and home equity -- as opposed to Income gains -- to finance an improving lifestyle. After the vacations are passed, the big screen TV and new cars become old, what are you left with?

Appreciation in the value of your home has long been considered a form of forced savings (as in don't eat your seed corn). The economic boost is over, the savings impact is significant, and you are left with a financial hangover. Talk about a negative wealth effect.

For the banks, it raises all different manners of headaches. Unlike Mortgages, Home Equity loans are secondary against the collateral -- the house itself:

"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. Banks holding home-equity loans generally can only seize the collateral -- a house -- after the mortgage is paid off.

When another bank holds the mortgage and the mortgage payments are current, the home-equity lender is effectively powerless to collect the debt.

Unfortunately for home-equity lenders, many borrowers understand that pecking order, concluding there are few repercussions if they stop making payments on their home-equity loan... Other types of consumer loans also are souring, including credit cards and auto loans. But delinquent home-equity loans are rising faster, representing 12.5% of all delinquent loans in the fourth quarter at Bank of America Corp. (BAC), the largest U.S. bank in stock-market value. That was up from 9.4% in last year's first quarter, according to research firm SNL Financial.

Pretty amazing stuff.

The bankers are finally asking themselves "How the hell did we get into this mess?" The answer surprises no one:

Leaning on outside mortgage brokers for home-equity business was "one of the biggest mistakes we've made." Those loans have performed worse than home-equity loans generated by J.P. Morgan.
-Charles Scharf, head of J.P. Morgan's retail business.

Indeed...

Source:
Latest Trouble Spot for Banks: Souring Home-Equity Loans
Losses May Hit Lenders That Skirted Subprime; Surprise Delinquents
ROBIN SIDEL
WSJ, March 12, 2008

Comments

[Richard Shi...:]

Barry,

You are really bumming us out here. We need more denial not more reality. We absolutely have to get on the same page, the consumer exists to spend, that is what HELOC's are for! That is what credit cards are for! In tough times we can't under any circumstances stop spending! If the consumer can't borrow then it is the government's job to borrow for them-and mail them checks to keep spending! The fed can take these HELOC's on their balance sheet! There is absolutely no problem here whatsoever. The market is up 500 points in 2 days, what is your problem Barry! Get with the program! Your one of those "save and invest" guys aren't you?

2008 Mar 12 12:06 PM

[GaryD:]

That quote by Chuck Scharf is a joke. My brother-in-law worked at Citi when home equity loans first came out. They were told by senior management to push that crap and got big bonuses for doing so. At the time I thought that they were crazy to expect people to go out and get second mortgages on their homes to buy "stuff"; appararently I don't have a good grasp of human action. The bankers knew exactly what they were doing from the get-go. Now they want to blame the mortgage brokers, th government, the homeowners, anyone. They probably had a plan set up fifteen years ago that predicted a blow up, and a little chart that showed how they were going to pin the blame on everyone but themselves. Now they dump the crap on the fed, which amounts to a taxpayer bailout funded through inflation. What a crock. When do we get to tar and feather these guys?

2008 Mar 12 01:10 PM

[Parkite:]

GaryD - Who had a gun to the homeowner's head making them take the HELOC? Whatever happened to personal accountability for one's actions?

2008 Mar 12 01:52 PM

[Reinko:]

Last year in the Summer when the 'credit crunch' finally opened after waiting so long, I sometimes told people here in Europe that Amercans has so called home equity lines of credit.
That is a credit card on your house I told them.

More often than not, these people were stunned, shook their heads in utter disblieve and sometimes managed to say stuff like 'But that is crazy!'

And they went utterly nuts when I told them the fairy tale of the climbing leverages: a bank leverages stuff 15 times and when they have about 40% decline of total value, they leverage it with 25...

That was enough, most of them went through the roof...;)

2008 Mar 12 05:08 PM

[Expat:]

the average US consumer is apparently pretty stupid, at least about things like finance, savings, mortgages. The average US banker also seems pretty stupid, or is at least blinded by greed.

So who is to blame? Everyone (mostly). The idiots who took out HELOCS. The idiots who loaned out the HELOCs. The rah-rah morons on CNBC who cheered every rise in house prices and every increase in consumer spending. The Fed for facilitating and openly approving all this. The SEC for not regulating anything at all. The White House for letting it happen, profiting from it, and making sure Wall Street got its bonuses. The investment banks who packaged it all up and sold it out. The rating agencies who took the cash, closed their eyes and lied their asses off.

Who in power (media, banking, or politics) ever pointed out that rising consumer spending combined with falling real incomes is not a good thing? Who raised any alarms about the massive leverage and debt being created in financial markets? Who really wanted to moderate house prices on the way up? Who really wants to see them go down?

Everyone is guilty, but guess who will pay? Not Mozillo, not Prince, not Greenspan, not Bush, not Summers. Nope. Middle class and lower class America will pay, because they always do. Foreigners will pay because, well, we pretty much dislike them all anyway. A few rich guys will be served up as token sacrifices to the media, but most will get away with millions of dollars "earned" from the bubble.

There is no acceptable solution so look out for the most bizarre, perverted, and dangerous moves from Washington. Outright government purchases of mortgages and MBS's. Direct government funding of a few major banks or broker/dealers. War with Iran. A few more terrorist attacks in the US and abroad. Inflation at 15-30%. Euro at 2.00 USD. Yen at 75.

2008 Mar 13 12:02 AM

[cromag:]

Two points to address;

1) The HELOC lender can foreclose on the borrower in default if the HELOC lender keeps the lender in first position current. (makes the payments for the borrower) Many times this first position lender is one in the same so that make it a little different but the HELOC lender would need to take the borrower to court to get the money they paid to keep the 1st mortgage current as well as all other fees, expenses and losses the HELOC lender incurred. The way they get this money is by selling the house and taking the monies from the sale and leaving any left over for the borrower. However, with values declining this is pretty much a losing proposition for the lender unless there is sufficient equity remaining to see this all the way through.

2) I would not blame everyone for this. I would blame the investors in the secondary and whoever was pitching the wholesale loan product to them. I say this because, all bubbles aside, I can distinctly remember about a year ago or more when 100% financing was getting to be old news and fear of NegAm loans was almost non existent when, what did I see... another new loan product staring at me... the 100% NegAm purchase money loan! Get an 80% first loan and they had a lender dumb enough to give you a 2nd for the remaining 20% and... are you ready for the best part... you didn't even need to prove your income for the already lax qualifying standards! It was then that I got a bad feeling about the whole loan business and wondered what the heck they were telling the investors in the secondary, to go for this stuff.

The banks and brokers were being bombarded with these and other new loan products daily and the competition was fierce. It wasn't hard to see the pressure that the investors in the secondary must have had, to get more market share rolling out new products and pushing the risk envelope but the 100% Stated Income NegAm Purchase from lenders like eNegam.com and others was a recipe for doom. It's too bad that those investor who were sold this wall street spinster, toilet paper, eventually ended up being 'us' regular investors in our regular mutual funds and 401k 'retirement' plans and pension funds. It's too bad that the secondary never consulted with us before they said ok to these <cough> investments because it wouldn't have taken a high school dropout to figure out these laughable loans and lax guidelines would end up in foreclosure. I guess they can all go back to their old jobs washing dishes and giving you your dry cleaning because they took us all to the cleaners.

Full Disclosure: I'm still a Mortgage Broker.

2008 Mar 13 02:10 AM

[Hoot:]

It turns out that the HELOC can actually be the cure for the headache. There is a software system available, when used in conjunction with the HELOC, that allows for the accelerated payoff of the 1st, without increasing the monthly payment. The system actually pays down the 1st and the 2nd at the same time.

This is a tremendous innovation in finance and currently is being used by tens of thousands of homeowners with the numbers growing daily. I am a licensed California mortgage broker and my clients are saving huge amounts of interest by paying off their mortgages much, much earlier.

Readers who want to know more, can go to my web site and click through to a replicated web site for an official company description of the product. There is also a tab there titled "accelerated mortgage" that adds further info.

As the reporters from the Channel 3 Las Vegas money news team say in the video, "folks, this just works".

Yours for the taking.

2008 Mar 13 11:22 AM

[cromag:]

Hoot

You should have a hard look at that 'new' loan that you are advertising. I took a hard look at the numbers with my own Excel spreadsheet and it looks like just another flim flam.

2008 Mar 13 12:09 PM

[Bingo 2:]

Barry Ritholtz should be in charge of the Fed. He is one of the few who grasp the situation. He shows a fine understanding of the current problems.

2008 Mar 13 01:25 PM

[Hoot:]

Cromag, It is not a loan. It is software. You can spreadsheet your numbers to death, and you won't match the optimization of running all your income and expenses through the HELOC. When you do that, you create an interest cancellation event. It actually creates a payment savings which the software then takes a portion of, and adds it to a portion of the discretionary income, and prompts the user to write a check from the HELOC (to the exact penny) and send to the 1st lien holder.

You can call this any name you want, but if you will look at the web site I suggested, you will also see a BBB rating which shows zero complaints from the thousands of users. In fact, they are all running ahead of schedule. Once users get into it, they see how much they can do by budgeting better and increasing disposable income and thus accelerating the mortgage even faster.

And finally, if you will take the time to look, the 3 reporters covering the story buy the software for themselves. Their opinion of its effectiveness is unequivocal. Ask yourself, what would be the liability to this tv station, upon such reporting, if it were as you suspect? How much money would they be sued for?

I'm not here to pitch this thing, just bring added light to a solution for many faced with the difficulty of home prices declining faster than they can pay off the debt.

2008 Mar 13 01:51 PM

[cromag:]

Hoot

Hardly 'unequivocal'.

I got wind of this 'software' from CMG Financial in 2005 IIRC and was solicited by them about a year ago.

There is a lot of what I call 'guerrilla marketing' out there that is disguised as news.

The BBB is a paid by the company who wants to use it's log and services and just because there are no hits on it 'yet' does not mean that everything is alright. Haven't you learned anything from this whole sub-prime fiasco??

2008 Mar 13 02:45 PM

[cromag:]

I see you have an economics degree from Berkley which is a phenomenal school so let me add;

I wrote this off last year and I'm now taking the time out of my day to look into it again to explain the details of my skepticism.

BBIAF

2008 Mar 13 02:52 PM

[cromag:]

Have you ever heard of the "Confidence Man"?

Are you suppose to open a new HELOC to function as an, LOL, "Interest Cancelation Account"?

The flaw I see in their designed and biased 'comparison' is that they don't compare it with someone doing a similar strategy without paying for the software and without treating their home as a checking account.

You're suppose to put all of your money that is currently earning interest, into this HELOC that is currently costing 7.5% (as an example of a rate which could easily increase 4% or more in a short time as it did from June 2004 to June 2006 and with little threat of inflation!)

With all the volitility lately I can easily see Prime going up 4% in a much shorter time that last time and making a 7.5% HELOC a 11.5% HELOC while a person whole did a consolidation loan instead of this sham would still be at their 5.5% 30-year fixed loan and breathing a sigh of relief as they watched the rate skyrocket with the threat of inflation. Just imaging if these people had a 3 or 5 year ARM or an Option ARM with a 110% balance cap! Sheesh But I digress...

Yo're suppose to put your money into this HELOC and treat it as an expense account and then pay down your 1st mortgage in large chunks so as to reduce the term and interest cost. You can easily do this without a HELOC and without a software program to tell you how much. In fact, why not do it with a no transaction fee, zero interest introductory rate credit card?

This plan makes people comfortable with using their home as a checking account and as it is painfully obvious at this time, people will use the credit to which they have easy access.


It's a thing of beauty to have the people from World Savings (now Wachovia) design such a product, as they are the kings of the NegAm loan. They conveniently omit many areas and divert attention to the largest changes that promote paying down a 1st mortgage, thereby influencing people to jump at the 'opportunity' or at least inquire. And if they do see the rouse, since they are sitting in front of you explaining it to them anyway, why not just go with your other plan, to refinance them with a different strategy.

Here's a quote from Chris George of CMG. "To ensure the program is explained accurately, CMG requires mortgage brokers to earn a certificate and not miss even one question on the test."

Two thumbs down for this product and the charlatans peddling it.

Please do respond with any error I may have stated or benefits I may have missed. I could easily be enticed to work up and post an exacting spreadsheet of a better comparison and better plan that costs nothing or less with much less risk.

In the end, this product is a great way to get people to refinance more often and communicate with their mortgage broker more often which is great for business but not a good strategy for long term client retention and not for most to reduce their debt.

JMHO

2008 Mar 13 03:39 PM

[cromag:]

Hmmm

I'm a little confused. Are you Hoot or Charles? Your website Lic# leads to Charles in the DRE records but Hoot Gibson has an expired License and you are advertising that you are a broker named as Hoot Gibson. Can you please explain?

www2.dre.ca.gov/Public...

License Type:
BROKER

Name:
Gibson, Hoot

Mailing Address:
PO BOX 1355
PALM SPRINGS, CA 92263
(Above address is marked unreliable in DRE database)

License ID:
00351478

Expiration Date:
08/23/97

License Status:
EXPIRED

2008 Mar 13 03:56 PM

[Hoot:]

Hoot is my knickname, and so post the License # as required. Just do a search using the license #. Don't know the Palm Springs number. Sorry.

2008 Mar 13 04:32 PM

[Hoot:]

Cromag, Is see what happened. I post my license number at my web site. I thought you might had seen it there. Instead, you did a search for Hoot Gibson. Try #01722105

2008 Mar 13 04:38 PM

[User 379040:]

hello,it is hard to get what we search and what we have got?

Mar 19 05:00 AM