In, Predicting the Timing of HELOC Payment Shock, we learned that 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.
Motivated to discern the timing of HELOC reset risk, TU Financial Services analysts conducted a study. In today’s post we will examine the metrics around the third of three dimensions of risk at the consumer level, the presence of a viable strategy for exiting the debt obligation.
To catch up on the first two dimensions of risk in our study, click here for Dimension 1: Credit Risk of the Consumer and here for Dimension 2: Consumer Capacity to Absorb Payment Shock.
Part 4 of 5
Our third dimension of risk is the ability of the consumer to exit the HELOC debt obligation, if necessary, through refinancing, restructuring, or sale of the home. We learned during the recession that having sufficient positive home equity is usually an important component of successfully navigating any of these options. The theory here is that those consumers with limited or negative equity may have trouble exiting the HELOC obligation and would therefore be more likely to default if faced with liquidity constraints.
We obtained home value data as of December 2013 from our partner CoreLogic® and combined it with the mortgage and equity loan/line data in our consumer credit database to calculate the cumulative loan-to-value (CLTV) ratio for each HELOC borrower, wherever home value data was available and successfully matched to the consumer credit data.
Table 3 shows that CLTV is another effective HELOC risk metric, which comes as no surprise; mortgage and equity lenders have used CLTV as a risk splitter for decades. It is not as strong a risk differentiator as credit scores (which most mortgage lenders use), nor is it as strong as AEP (which most mortgage lenders do not use). Even so, CLTV provides respectable separating power, with a factor of 2.6x between delinquency in the lowest CLTV tier and that in the highest tier.
Using 90% CLTV as our delineation for higher risk in this dimension, we see that approximately 30% of the population presents elevated HELOC risk due to limited exit-strategy options. With this third dimension, we have found a measure that does a good job of narrowing the band of consumers about whom we should be concerned.
In their own way, the three metrics each do an excellent job on their own identifying which HELOC borrowers may be at elevated risk of default. The next step is to understand what lift we can achieve when these metrics work in concert.
Stay tuned for our next post which will take a deeper dive into using multiple risk strategies.
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.