I recently wrote a blog about real estate being the “great gift” that has kept giving throughout 2013. The question remains as to whether it can continue
to give at the same pace in 2014. One interesting – and perhaps frightening – piece of data places a big question mark on that idea.
Think back to 2003-2004 when the equity and real estate markets were booming. Individuals seeing healthy property appreciation felt comfortable using their
homes as a sort of bank account they could draw against in the form of a HELOC – home equity line of credit – to finance home improvements, college
education, cars, vacations, etc. These loans are second mortgages that carry flexible withdrawal terms and interest-only payments for the first 10 years of
the loan. Once you get to the ten year point, however, things begin to change as these loans carry mandatory resets requiring borrowers to begin paying
both principal and interest on their balances.
According to federal financial regulators, an estimated $30 billion of home equity lines dating back to 2004 are due to reset next year. In 2015, this
number may be as high as $53 billion. The real issue here lies in the preparedness – or lack thereof – of individuals to calculate what this reset means.
For many of these loans, the difference between the interest-only and reset payments can be substantial – $500-600 per month or more in some cases. If
borrowers haven’t prepared for this increase and cannot afford to make the full amortizing payments that reduce the principal debt, the bank that owns the
note can look at refinancing the borrower, make modifications to the existing loans or demand full payment of the balance. In the worst case scenario, the
banks can foreclose on the loans if sufficient equity in the homes exists. Assuming that the first two options – modifications and refinancing – would be
the preferred resolutions, it sounds simple enough, right? Well, not exactly.
Refinancing on a mass scale may not be possible as many of these homeowners won’t qualify under the new tougher mortgage rules taking effect in January
2014. In addition, some homes have not appreciated enough to ensure that the value of the first and second mortgages combined doesn’t exceed the current
market value of the homes. Many of these homeowners with high balance credit lines already have low credit scores – legacies of the housing bust and
recession – thus giving them a statistically higher risk of default after a loan reset.
Many financial regulators are aware of this potential storm. They have asked the biggest banks to set aside extra reserves for possible losses. Just last
month, Citigroup said it is increasing its reserves nearly $20 billion for these home equity lines as they acknowledged that the reset payment could be a
“shock” for many borrowers.
This information is important to those of us trading/investing in the equity markets. As we sit at all-time highs on our indices, we have to factor into
our decision making the potential impact this information may hold. We know that the equity markets react to each and every mere mention of the idea of a
tapering process in the Federal Reserve’s mortgage back security purchases. When this tapering begins, it is highly likely that the interest rate on these
loans may increase, further exacerbating this situation. While it may not carry the same degree of potential perilous results for equity markets as seen in
2007-2008, it certainly could cause a significant hiccup in the bullish run. It becomes critical as the markets continue to make new highs that individual
investors understand how to protect the gains achieved in their portfolios this year. That’s where OptionsAnimal comes in. We teach individuals how to
protect their gains as well as how to profit from any turbulence that the markets may endure. With this knowledge, investors can remain in the bullish
trend knowing that they can protect when/if the great “storm” truly arrives. For those of us possessing that knowledge, it means sleeping well at night –