As regulators have warned, millions of home equity lines of credit will be hitting their respective end of draw (EOD) periods over the next few years. Before EOD, usually only interest payments are required. Once a HELOC hits EOD, a borrower must cover the debt of a fully amortized payment in the pay-down period—that is, interest plus principal. This increase in payment may cause some borrowers to default on their HELOCs, or default on one or several of their other loan products in order to pay the HELOC. Ultimately, it is an issue of consumer liquidity affecting lenders (with and without HELOC portfolios) who could lose hundreds of billions of dollars when borrowers come to terms with this payment shock. The lack of insight into the timing of that payment shock risk is one of the causes of concern in the marketplace, and a component of the motivation for our study.
Part 1 of 5
To address this gap in insight, TU financial services analysts have developed a multi-dimensional framework to predict the timing of HELOC payment shock at the individual level. In this first part in a series of 4, we’ll examine the dynamic analytics and metrics TU applied to define the timing of the risk.
Let’s take a look at the numbers behind the study.
As of September 2014, some 15.4 million U.S. Consumers held $456 billion in HELOC debt. Some $352 billion of that debt had yet to reach EOD and potentially experience payment shock. In order to give lenders a timeframe to prepare, we first had to estimate the actual timing of HELOC payment shock at the individual level. This required an estimation algorithm that correctly predicted the EOD point. To understand EOD timing, we explored more than 185,000 HELOCs that had a clearly identified EOD, finding that 56% had a 10 –year draw period, and only 17% had a draw period of less than 10 years. Combining these facts with various decision rules, we constructed an allocation model that correctly predicted the EOD point 81% of the time. This goes a long way toward helping lenders anticipate when they might need to act to help consumers avoid or mitigate HELOC payment-shock risks.
Using our vast consumer credit data coupled with analytical exploration, we find HELOC reset is manageable. This means we can focus on problem solving and strategic planning. We have the ability to identify the timing of potential risk and address it with manageable strategy. Using TU data and analytics, lenders can be proactive in helping customers avoid defaults and manage their personal balance sheets effectively. With so many HELOCs due to hit EOD over the next few years, now is the time for lenders to prepare.
Visit back soon for Part 2, Credit Risk of the Borrower, where we will explore metrics along the first of three dimensions at the consumer level, the credit risk of the consumer.
For more on this topic and the study, see our article in RMA journal, Understanding HELOCS: Facts versus Fear. Subscription to RMA Journal required to view full article.
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
Need help addressing the concern? Submit your information below to have a TU financial business expert contact you.
- 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.
