Home Equity Lines of Credit Problems Are Not Over

Conclusion from the NY Fed Study on Second Liens

 

We use data from credit report and deeds records to better understand the role of second liens in contributing to the housing boom and subsequent foreclosure crisis. Overall, second liens appear to have allowed borrowers to take on additional leverage, although it is not possible to say whether borrowers might have turned to higher LTV first liens if attractively priced second liens were not available. However, part of the reason that second liens were attractively priced is that many second liens were originated to higher quality borrowers than the average first lien borrowers. Within the category of second liens, home equity lines of credit (HELOCs) appear to be the best credit quality, with relatively few piggyback originations, higher quality borrowers at origination, and a smaller percent originated near the peak of the housing boom. Closed end second lien characteristics were worse on all these dimensions. While home equity extraction appears to be large factor behind increased borrowings, especially for HELOCs, such borrowings went to relatively high quality borrowers who likely would have had access to some additional credit even without using a HELOC.

Second liens were quite prevalent at the top of the housing market, with as many as 45 percent of home purchases involving a piggyback second lien in coastal markets and bubble locations, but a somewhat smaller prevalence of piggyback second liens in more stable or declining markets in the Midwest and South. Second liens were strongly associated with the use of low down payments to purchase homes. Owner-occupants used second liens to help finance a higher percentage of purchases than investors. These data are consistent with the hypothesis that piggyback second liens allowed some borrowers to purchase homes with especially low down payments who might otherwise not been able to afford a home. That said, it is not possible to demonstrate a causal link between second liens borrowings and the housing bubble and subsequent collapse.

The default rate on a second lien is generally similar to that of the first lien on the same home, although about 20 to 30 percent of borrowers will pay the second lien for more than a year while remaining seriously delinquent on their first mortgage. By comparison, about 40 percent of credit card borrowers and 70 percent of auto loan borrowers will continue making payments a year after defaulting on their first mortgage. This behavior can be due to a combination of several reasons, including strategic default on the first lien to obtain a modification, behavioral explanations that depend in part of borrowers directing available funds to the accounts with the smallest minimum payments, and the fact that defaults on second liens very rarely result in the loss of a home.

Finally, we show that the relatively low delinquency rates for HELOCs have remained flat in recent quarters even as delinquency rates are falling for most other types of credit. Given that the bulk of outstanding second liens are HELOCs, such performance could signal that problems are not over for some lenders with large portfolios of HELOCs on their balance sheet.