Home-Equity Loans Turn to Poison

Home-equity loans appear to be the next source of problems for consumers and as banks. Lenders made billions of dollars in the past by allowing consumers to tap the accumulated value in their properties with either a loan or a line of credit. However, these profits relied on the assumption that housing prices would continue to rise. Obviously, falling home values are now leaving banks with little or nothing to collect on many home-equity loans in case of default.

JP Morgan and Wells Fargo are two companies that already experienced a hit from these home-equity loans while many others are also expected to take a hit thanks to tighter lending standards as banks try to reduce their risk. JP Morgan expects about $450 million on losses in the first quarter of this year on its $95 billion home-equity portfolio, which is up from $248 million in last year’s fourth quarter. These are well beyond any models and continue to get worse.

The biggest problem with delinquent home-equity loans is the lack of any recourse. A defaulted mortgage means that lenders can go ahead and repossess the property. However, banks have very little recourse for recovering home equity loans, especially if another bank holds the primary mortgage. Generally, they can only seize the house if the mortgage is already paid off or other lenders are already paid off.

The losses on home-equity portfolios will not be nearly as large as the defaults on subprime mortgages, but they are another notch in the belt of banks already swamped with losses. Banks will be forced to increase their loss reserves for these home-equity loans, which will likely end up tightening credit in many other areas of banking. This is bad news because it will likely mean higher mortgage prices, home equity interest rates, and other product prices.

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