As prefaced in our previous post, Part 1 – Predicting the Timing of HELOC Payment Shock, millions of home equity lines of credit will be hitting the end of draw (EOD) period over the next few years, which may cause some borrowers to default on their HELOCs due to the payment shock of full amortization (interest plus principal payments). Lenders with and without HELOC portfolios have billions of dollars exposed to borrowers who may be unprepared for this payment shock.
In part one of this blog series, we laid the foundation of the study conducted by TU Financial Services analysts to discern the timing of HELOC reset risk. In today’s post we will examine the metrics we sought to develop around the first of three dimensions of risk at the consumer level, the credit risk of the consumer.
Part 2 of 5
As part of the study, TU Financial Services analysts used a consumer credit risk score, VantageScore 3.0, as a candidate metric for measurement, with the idea that each consumer’s inherent credit risk would likely be a strong indicator of performance on a HELOC.
Table 1 below shows VantageScore 3.0 credit risk score does an excellent job of identifying risk among HELOC borrowers, as those with higher scores have lower incidence of default in the draw period. For the sake of the study, we chose a score cutoff of 680 as the delineation of higher risk, which corresponds loosely to a prime-nonprime transition point—of course, any individual lender could pick the score cut-off that best aligns with his risk tolerance. HELOC table 1Given this cutoff, we found that only 24% of HELOCS present an elevated risk due to the poor historical credit performance of the borrowers or inability to assign them a score. While 24% is still a relatively large number, this is already a material improvement over considering all of the $352 billion in HELOCs yet to reach EOD as high risk.
For more on this topic and the study, download the full article Understanding HELOCS: Facts versus Fear, recently featured in the RMA Journal May 2015 edition.
Next steps for mitigating HELOC EOD risk:
- Initiate a portfolio review to understand extent of exposure, how many HELOCS are going to hit end of draw, and individual consumer ability to absorb shock
- Identify and analyze lender risk, pricing, credit limits and metrics around loan to value
- Determine how you move forward with prospective customers
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- For our most recent study on the consumer payment hierarchy, see “Take Heed of Consumers’ Changing Payment Hierarchy” in the December 2013 / January 2014 issue of The RMA Journal.
- For an in-depth discussion of AEP and the related metric, total payment ratio, see “The Almighty Payment: Why It’s Important to Study Debt Service Behaviors” in the March 2014 issue of The RMA Journal.
- Data Source: TransUnion consumer credit database.