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Home Equity Part 2: Underwriting Standards

Stay High As Volumes Rise

Sam Khater    |    Mortgage Performance

Home equity lending, as discussed in Part One of this blog, is making a comeback. But the last time home equity—or more specifically, subprime home equity—boomed it was enabled, in part, by very loose underwriting standards, and we all know how that turned out. So how’s the underwriting this time around? In a word: tight!

A new analysis of lines and loans originated in 2015 shows that the average LTV is 61 percent, roughly where it has been since the crash seven years ago.

Likewise the average credit score is 777, which is more than 40 points higher than it was in the pre-crash days of 2005.

Debt-to-income ratios are in the 34 percent range well down from their highs, of 38 percent in 2006.

The delinquency rates for home equity are back to pre-crash levels. In September, 90-day plus delinquencies for U.S. home equity lines of credit stood at 1.18 percent. Overdues have stayed steady at this low level for the past six months.

(For context, the worst month for HELOC delinquencies was December 2010, when 90-day-lates stood at 3.31 percent. Overdues of this type have come down more than 200 basis points since then, an almost two-thirds drop.)

Based on what we are hearing from clients, and seeing in the numbers, banks and credit unions are still treading lightly as they get comfortable with home equity risk, once again.

Many lenders are focusing first on existing clients, where they have higher comfort levels and can use public record and transactional data to assess borrower income levels and equity before inviting them to apply.

Regulators are also watching more closely. So gone are the days of streamlined, “cup of coffee” decisions based on a simple AVM and a credit report. Closed end seconds, once a popular way to avoid mortgage insurance, now fall under the Qualified Mortgage rule and must pass ability to repay tests.

But while new originations are fairly pristine and performing well, what about legacy lines and loans? As a vintage, home equity loans originated during the go-go years of the last decade are performing worse than the home equity category in general.

Late last year we examined the effect on delinquency that home equity finance resets had, and it was significant. The 2003 and 2004 cohort of loans saw a doubling of monthly payments after the reset and a four-fold increase in 60-days-plus delinquencies to more than 400 basis points. That doesn’t bode well for the 2005 and 2006 vintages coming due now and next year. However, many of the weaker credits for loans originated in those years may already have defaulted, lessening the pain point this year and next.

Lenders over the past few years have taken proactive measures, where possible, to refinance or modify at-risk HELOCs, particularly those nearing their 10-year conversion point to full amortization. This has significantly reduced the number of loans facing pay shock and forestalled the worst-case default scenario predicted by some analysts.

Having said that, the smaller cohort of active legacy loans that haven’t been refinanced, due to a lack of equity or income, continue to present an adverse selection challenge. Because of their relatively small number, they haven’t significantly changed the overall performance metrics for home equity.

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