The $1.1 Trillion HELOC Problem

The New York Times is writing Home Equity Loans as Next Round in Credit 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.

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.

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

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.

“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.

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.”

The article notes that 5.7 percent of home equity lines of credit were delinquent or in default in December 2007, up from 4.5 percent in 2006, according to Moody’s Economy.com. It's not unreasonable to assume with the the recession picking up steam that 10-15% of those $1 trillion in HELOCs and second mortgages will default. If so, add another $100-$150 billion in writeoffs. That number can easily be low.

The Latest Fad

Arizona Central is reporting about the latest fad: Hunting for foreclosure deals.

During the housing boom, investors flocked to metro Phoenix and climbed onto buses that took them to the Valley's fringes, where they checked out affordable new homes they could buy low and sell high.

Now, the bus tours to those edge suburbs are starting again. But this time, home buyers are looking for foreclosure properties they can flip for a fast profit.

My comment: Insanity never stops. Wake me up when flippers give up.

The Valley's foreclosure-buying spree started with auctions last fall. Late-night infomercials turned from buying homes with little down to foreclosure-investing. Daylong foreclosure-investing seminars in Valley hotel conference rooms, including sessions held by Trump University, began filling up in January. Smaller bus tours put on by local real-estate agents are going on most weekends now, and a national group called Foreclosure Bus Tours today will hold its first daylong event in the Phoenix area.

My Comment: There is no foreclosure buying spree. However, there are a bunch of "Trump Artists" making money promoting the idea.

"Foreclosure-investing is the real-estate buzzword now," said Eric Brown, a former Phoenix home builder who is a managing director of real-estate consulting firm Robert Charles Lesser & Co. "Huge investment companies and individuals are looking to pick up properties cheap."

My Comment: I would advise staying away from anything that becomes the "buzzword".

Foreclosure Bus Tours has shuttled investors around Detroit, Fort Lauderdale, Fla., and Boston, and it has tours planned in Dallas and Houston as well as Maryland and Connecticut. For $97, investors get lunch and check out several foreclosure properties. Usually, a local real-estate agent and mortgage broker is on the bus to get deals going.

My Comment: For $97 you get to listen to real estate shill pitch crappy deals to a captive audience.

"Last time around, it was the amateurs who believed the infomercials and used all the home equity in their own homes to buy rental properties," said Jay Butler, director of Realty Studies in the Morrison School at Arizona State University Polytechnic.

"Now, many of those houses are in foreclosure and selling to a similar group of investors."

My Comment: People flying in from Chicago or wherever and don't know the local conditions are going to get taken. The local professionals don't need a tour bus.

Most Valley homes in foreclosure don't have any equity left because of falling home values. More than 95 percent of the houses going into foreclosure are going back to the lender because no one wants to bid on the houses with upside-down loans, which are worth less than what is owed on them.

My Comment: That is another gotcha. Banks want their investment back no matter how unrealistic that is.

Some homeowners are trying to avoid foreclosure by doing short sales. But Brett Barry of Realty Executives said many lenders aren't willing to negotiate, particularly on home-equity loans or second mortgages, and that is forcing more people into foreclosures.

Lenders won't deal

"Lenders just won't deal, and it makes no sense because it's only going to cost them more money, particularly when the houses are going for so cheap at auctions," Barry said.

My Comment: There's the home equity/second mortgage trap again. It is preventing deals from getting done. Second lien holders want something. Why should they approve a deal and get nothing out of it? First lien holders are being too stubborn. Bankruptcies will result instead of short sales. Everyone loses.

Diane Drain, a Phoenix bankruptcy and foreclosure attorney, is seeing the same thing. She said she is working with two to three investors a day who are going to lose homes to foreclosure because lenders won't negotiate with them.

She cautions people investing in foreclosures to spend only money they can afford to lose.

"If it's money you would take to Vegas and drop on a table, then invest it in foreclosure properties," Drain said. "But if it's your retirement account or home equity, don't touch it. I am seeing too many people now who are losing everything because they invested in homes they thought they could flip for a profit."

My Comment: Finally, we see some practical advice.

Key Points

• The idea that one can buy foreclosures and flip them quickly for a profit is complete silliness. There is simply to much inventory. Exactly who is the flipper going to flip to?
  
• Banks are still holding out for too much money on foreclosed properties.
• Second mortgages are preventing deals from getting done.
• Refusal to deal is hurting all the parties involved and increases losses on the first lien holder.
• Refusal to work out short sales will increase bankruptcies.
• Bills to alleviate this mess will fail because Congress excluded second liens. Actually, no matter what Congress does it will fail. The best thing Congress can do is nothing.
  

The home equity problem is two fold. The easily seen is the $100-$150 billion (or more) in future writeoffs. Beneath the surface is the damage caused by all these loans originated with 0% down, and/or HELOCs involving multiple companies with multiple liens. The latter is slowing down deal making and will eventually result in more personal bankruptcies.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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