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Equity Loans as Next Round in Credit Crisis
By Vikas Bajaj
The New York Times
Thursday 27 March 2008
Little by little, millions of Americans surrendered equity in their homes in
recent years. Lulled by good times, they borrowed - sometimes heavily
- against the roofs over their heads.
Now the bill is coming due. As the housing market spirals downward, home equity
loans, which turn home sweet home into cash sweet cash, are becoming the next
flash point in the mortgage crisis.
Americans owe a staggering $1.1 trillion on home equity loans - and banks
are increasingly worried they may not get some of that money back.
To get it, many lenders are taking the extraordinary step of preventing some
people from selling their homes or refinancing their mortgages unless they pay
off all or part of their home equity loans first. In the past, when home prices
were not falling, lenders did not resort to these measures.
Such tactics are impeding efforts by policy makers to help struggling homeowners
get easier terms on their mortgages and stem the rising tide of foreclosures.
But at a time when each day seems to bring more bad news for the financial industry,
lenders defend the hard-nosed maneuvers as a way to keep their own losses from
deepening.
It is a remarkable turnabout for the many Americans who have come to regard
a home as an A.T.M. with three bedrooms and 1.5 baths. When times were good,
they borrowed against their homes to pay for all sorts of things, from new cars
to college educations to a home theater.
Lenders also encouraged many aspiring homeowners to take out not one but two
mortgages simultaneously - ordinary ones plus "piggyback"
loans - to avoid putting any cash down.
The result is a nation that only half-owns its homes. While homeownership climbed
to record heights in recent years, home equity - the value of the properties
minus the mortgages against them - has fallen below 50 percent for the
first time, according to the Federal Reserve.
Lenders holding first mortgages get first dibs on borrowers' cash or
on the homes should people fall behind on their payments. Banks that made home
equity loans are second in line. This arrangement sometimes pits one lender
against another.
When borrowers default on their mortgages, lenders foreclose and sell the homes
to recoup their money. But when homes sell for less than the value of their
mortgages and home equity loans - a situation known as a short sale -
lenders with first liens must be compensated fully before holders of second
or third liens get a dime.
In places like California, Nevada, Arizona and Florida, where home prices have
fallen significantly, second-lien holders can be left with little or nothing
once first mortgages are paid.
In December, 5.7 percent of home equity lines of credit were delinquent or
in default, up from 4.5 percent in 2006, according to Moody's Economy.com.
Lenders and investors who hold home equity loans are not giving up easily,
however. Instead, they are opposing short sales. And some banks holding second
liens are also opposing refinancings for first mortgages, a little-used power
they have under the law, in an effort to force borrowers to pay down their loans.
"Acknowledging a loss is the most difficult thing to do," said
Micheal Thompson, the executive director of the Iowa Mediation Service, which
has been working with delinquent borrowers and lenders. "You have to deal
with the reality of what you are facing today."
While he has been able to strike some deals, Mr. Thompson said that many mortgage
companies he talks with refuse to compromise. Holders of second mortgages often
agree to short sales and other changes only if first-lien holders pay them a
small sum, say $10,000, or 10 percent, on a $100,000 debt.
Disagreements arise when the first and second liens are held by different banks
or investors. If one lender holds both debts, it is in their interest to find
a solution.
When deals cannot be worked out, second-lien holders can pursue the outstanding
balance even after foreclosure, sometimes through collection agencies. The soured
home equity debts can linger on credit records and make it harder for people
to borrow in the future.
Experts say it is in everyone's interest to settle these loans, but doing
so is not always easy. Consider Randy and Dawn McLain of Phoenix. The couple
decided to sell their home after falling behind on their first mortgage from
Chase and a home equity line of credit from CitiFinancial last year, after Randy
McLain retired because of a back injury. The couple owed $370,000 in total.
After three months, the couple found a buyer willing to pay about $300,000
for their home - a figure representing an 18 percent decline in the value
of their home since January 2007, when they took out their home equity credit
line. (Single-family home prices in Phoenix have fallen about 18 percent since
the summer of 2006, according to the Standard & Poor's Case-Shiller
index.)
CitiFinancial, which was owed $95,500, rejected the offer because it would
have paid off the first mortgage in full but would have left it with a mere
$1,000, after fees and closing costs, on the credit line. The real estate agents
who worked on the sale say that deal is still better than the one the lender
would get if the home was foreclosed on and sold at an auction in a few months.
"If it goes into foreclosure, which it is very likely to do anyway, you
wouldn't get anything," said J. D. Dougherty, a real estate agent
who represented the buyer on the transaction.
Mark Rodgers, a spokesman for CitiFinancial, declined to comment on the McLains'
situation, citing privacy considerations.
"We strive to find solutions that are acceptable to the various parties
involved," he said but two lenders can "value the property differently."
Other lenders like National City, the bank based in Cleveland, have blocked
homeowners from refinancing first mortgages unless the borrowers pay off the
second lien held by the bank first. But such tactics carry significant risk,
said Michael Youngblood, a portfolio manager and analyst at Friedman, Billings,
Ramsey, the securities firm. "It might also impel the borrower to file
for bankruptcy," and a judge could write down the value of the second
mortgage, he said.
A spokeswoman for National City, Kristen Baird Adams, said the policy applied
only to home equity loans originated by mortgage brokers.
Underscoring the difficulties likely to arise from home equity loans, a Democratic
proposal in Congress to refinance troubled mortgages and provide them with government
backing specifically excludes second liens. Lenders holding a second lien would
be required to write off their debts before the first loan could be refinanced.
That could leave out a significant number of loans, analysts say.
People with weak, or subprime, credit could be hurt the most. More than a third
of all subprime loans made in 2006 had associated second-lien debt, up from
17 percent in 2000, according to Credit Suisse. And many people added second
loans after taking out first mortgages, so it is impossible to say for certain
how many homeowners have multiple liens on their properties.
"This is turning out to be a real impediment to solving this problem,"
said Mark Zandi, chief economist at Economy.com, "at least, solving it
quickly."
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