A potential crisis in home equity loans is looming as a result of the expected increase in payments for borrowers who obtained these loans during the housing boom. A report from Rutgers predicts that over the next four years, over 40% of all outstanding home equity loans worth $221 billion will reach the end of their interest-only period, requiring borrowers to start paying down the principal.

An increasing number of home equity loans, particularly home equity lines of credit, are reaching the end of their interest-only phase, requiring borrowers to start paying down the principal this year. These loans originated in 2003. A report from Fitch Ratings predicts that monthly payments for a typical borrower who took out a loan during the housing boom could increase by more than three times.

Data from Equifax shows that delinquencies on home equity loans have almost doubled in the current year, reaching 5.6% for loans originated in 2003, up from 3% for the same loans last year.

Are Rate Adjustments possible?

The monthly payments for these borrowers could increase even further if interest rates rise, as is expected with the Federal Reserve reducing its bond purchasing program. Most home equity lines of credit (HELOCs) are adjustable-rate loans susceptible to changes in mortgage rates, but they usually convert to fixed-rate loans after the interest-only phase ends.

Borrowers who obtained home equity loans during the housing boom are more likely to have negative equity in their homes, making it challenging or impossible to refinance their home equity loans or include them in their primary mortgage, both of which could lower their overall payments.

On the other hand, lenders may be open to modifying loan terms for such borrowers, especially if there is a high number of home equity loan defaults. Home equity defaults can be costly for lenders, often leading to complete loss, as they are not paid off until the primary mortgage is fully satisfied during foreclosure. This provides home equity lenders with a strong motivation to collaborate with borrowers facing financial difficulties and come up with an affordable payment plan.