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Home Equity Loan Defaults on the Rise

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Home equity loans and lines of credit are putting lenders in an even bigger pinch as the number of home equity defaults rises to record levels.

Countrywide Financial Corp, the lender with the nation’s biggest home equity loan book, announced last week its $32.4 billion portfolio of prime home equity lines of credit is deteriorating rapidly. The company took a $704 million charge as a direct result of home equity loan defaults.

And Countrywide isn’t alone. The loss rates are climbing for all lenders, according to Frederick Cannon, an analyst at Keefe, Bruyette & Woods.

Home equity lenders extended $504 billion in new home equity loans and lines of credit in 2006 and $456 billion in 2007. Estimating the extent of any one lender’s exposure to home equity loans is difficult because the risk is generally carried off the balance sheet. In other words, trouble isn’t always obvious until loans have deteriorated past a certain threshold.

What is clear is that defaults are rising. Home equity loan defaults have increased by nearly 50 percent in a year’s time and delinquencies on lines of credit have doubled in the same time period.

Not All Lenders Are Foreclosing

Although equity borrowers are defaulting in high numbers, some banks have been hesitant to foreclose on homes, choosing instead to walk away from the loans altogether.

“More often now than ever before we are writing off the loan,” says Bob Caruso, Bank of America Corp.’s national servicing executive. “The customer still owes the money, but it is no longer an asset on our books.”

This strategy may seem like a step away from the norm, but it is rapidly becoming the most prudent route for a home equity lender. Foreclosing can leave the lender deeper in the red because the owner of the first mortgage must be bought out.

Since falling home prices have insured the property’s value will not be enough to cover the costs of foreclosure in many cases, it’s generally better to just write off the loan.

Lenders Tightening Credit

Sixty percent of the U.S. banks responding to a recent Federal Reserve survey say they have instituted tougher criteria for home equity lines of credit. Lenders have also tightened guidelines considerably on home equity loans.  

Countrywide sent letters to 122,000 customers recently to announce that Countrywide was freezing the ability to draw from existing lines of credit.  The letters were sent to areas where home prices have dropped considerably, according to a Countrywide spokesperson.

Washington Mutual, Citigroup and the USAA Federal Savings Bank have all made similar moves, citing the right to do so under the borrowers’ creditor agreements.

Lenders have also begun to alter their definitions of good credit and ample equity. A score of at least 680 or 700 is now required to get a home equity loan in most cases, according Bob Walters, chief economist for Quicken Loans.

The state of the local housing market is considered by many lenders as well. For example, Bank of America allows borrowers to tap up to 90 percent of their equity throughout much of the nation. But the same lender limits the amount to 80 percent in areas like Miami and Las Vegas, where home prices have fallen.

The Los Angeles Times reported last week that Chase will take follow suit by limiting the maximum amount of equity that can be borrowed to 70 percent in Florida, California and other housing depressed areas.

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