Friday, August 1, 2008

HELOC Investment Warnings

There is an angle that is rarely covered regarding home equity loans - the investment angle. There is an interesting and informative article from the Wall Street Journal titled Home Equity Woes Tarry. In a very short piece the article discusses performance issues and investment issues. Lets take a look -

Banks have about $700 billion of home-equity loans -- in which a bank lends money to a homeowner against the equity in his house. That includes both fixed-rate loans and floating-rate debt drawn from credit lines. Lenders usually can't collect on a defaulted home-equity loan by seizing a house unless the borrower has no mortgage, since mortgage lenders have first claim.

The so-called piggyback loans are the riskiest of this home-equity debt. Most were taken out during the raging real-estate market. These loans came on top of a first mortgage, aren't backed by insurance and enabled some borrowers to buy homes without making a down payment. These loans represent more than 8% of the value of outstanding home-equity loans, according to SMR Research.

Many who were caught flat-footed when these loans turned sour now assume that home-equity loan risk already is factored into bank stock prices, which have tumbled. But investors may be too upbeat once again. For one thing, the recent news isn't exactly uplifting: 2.22% of all home-equity loans were charged off by banks in the second quarter, an all-time high. That is up from 1.69% in the first quarter and 0.9% in the fourth quarter of last year. Tax refunds and government-issued stimulus checks likely are at least partly responsible for why things aren't worse.

For investors, it would be best to avoid lenders with heavy exposure to home-equity loans written by outside mortgage brokers and other third parties that often employ lax underwriting standards. Instead, stick with banks that made their own loans during the real-estate surge.

Using this stance, investors should use caution when it comes to First Horizon National. According to a Goldman analysis, 15% of First Horizon's home-equity loans, or 5% of all its loans, were made by outside parties. Outsider-written loans represented 22% of Fifth Third Bancorp's portfolio, or 3% of its total loans. And 14% of Wells Fargo's home loans, or 3% of total loans, were written by third parties.

First the discussion of the secondary status of the home equity loans. This is a caution on the collection levels of the lines. A fair warning to those that are interested in investing - but it also some inside knowledge for those struggling to pay their bills to learn which ones will cause the least problems to stop paying first.

Second know the piggy-back loans were some of the worst business decisions from the Great Housing Bubble. There is no insurance for the lender and no incentive for the borrower. Most piggy-backs involved 100% financing - so many of these properties are already underwater. The owners were really just renting form the bank.

Third, is the latest performance issues. A 2.2% charge-off which is an all time high. Tax refunds and the stimulus package prevented this from getting higher. But analysts predict this has not leveled off and will not until the spring of 2009 at the earliest. So expect to see all times high to continue in this category for some time.

The last and most significant point of the article is the warning regarding investing in home equity lines from third party sources. The quality of these loans are all over the place and not worth the gamble. This is a big blow to independent and outside mortgage brokers.

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