It is now the time of HELÖCdämmerung: the twilight of the HELOCs. The feds are watching how banks handle this era, which is kinda like the morning after the drunken party.
A typical home equity line of credit, or HELOC, has a 10-year draw period, followed by a repayment period. The draw period is when the borrower drinks freely from the punch bowl. The repayment period is when the lender takes the punch bowl away.
Feds say that, when it comes to HELOCs, the fat lady is about to sing.
Or, to be literal and not so metaphorical: During the draw period, you can borrow up to the limit of the credit line, and the monthly payments are interest-only. But during the repayment period, you have to pay interest plus principal. Minimum monthly payments sometimes rise abruptly.
Fun, followed by a memo
Banks handed out HELOCs like Mardi Gras beads during the housing boom. And the boom was at its height roughly 10 years ago. Lots of those HELOCs will enter the repayment period over the next couple of years. So last week, regulators felt obliged to issue a document called Interagency Guidance on Home Equity Lines of Credit Nearing Their End-of-Draw Periods.
I find it sad that five regulatory agencies* believed it was necessary to alert banks that some of their customers will soon have trouble paying off their HELOCs. Shouldn't the banks know this? But banks have displayed so much incompetence that this document seems necessary. You might worry that this memo is a sign of regulatory overreach and paternalism. If so, I'm sure it's not the first time you've been wrong.
The regulators start out by assuming that banks will have to give their customers lots of extensions, renewals and modifications of their HELOCs. Helpfully, the regulators say that "lenders should conduct a thorough evaluation of the borrower's willingness and ability to repay the loan." Better late than never!
Faulty risk management
Don't expect banks to bat 1.000 in this endeavor. A few years ago, we owed a few grand on our HELOC, but our limit was much higher than the amount we owed. So the bank swooped in and reduced our limit to the amount owed, so we couldn't borrow any more. We had never been late on any house payments. Meanwhile, about 10 percent of the houses on our street ended up in foreclosure. The banks were terrible at sorting the risky borrowers from the solid ones. I wonder if they've gotten any better at it?
The regulators encourage banks to modify HELOCs for borrowers who have payment difficulties, but the feds make it clear that they want borrowers to repay principal. "Restructuring to an interest-only or balloon loan is generally inappropriate for higher-risk borrowers, as these types of loans do not directly address repayment issues," the guidance says.
Peer into the future
Finally, the regulators encourage lenders to look ahead and "consider the impact of payment shock and loss of line availability associated with the end-of-draw period." They're supposed to identify vulnerable borrowers in addition to calculating what the riskiest borrowers mean to the banks' bottom lines.
Reaching out to borrowers
Banks should contact borrowers six to nine months before their HELOC draw periods end, the regulators recommend. "Many successful programs have required several attempts to contact borrowers to achieve the most effective timing and messaging," the document adds. So if you feel like your lender is pestering you, blame the feds.
*The agencies are the Comptroller of the Currency, Federal Reserve, Federal Deposit Insurance Corp., National Credit Union Administration and Conference of State Bank Supervisors.