Over the next three years, 60 percent of home-equity lines of credit (HELOCs) are coming due, setting the stage for a new wave of potential credit losses for banks and other lenders. The majority of these loans—opened at the height of the housing bubble when underwriting standards were less stringent than they are today—will reach the 10-year mark between 2015 and 2017. Roughly $30 billion in outstanding home equity loans are due to reset by the end of this year, according to the Office of the Comptroller of the Currency.
As these HELOCs mature, and borrowers must begin to pay interest and principal versus interest alone, many consumers will see their payments as much as triple. A recent report from Moody’s Investors Service illustrates the payment shock in dollars: A homeowner with a $40,000 line of credit balance and a $210,000 mortgage at 4 percent interest could face a 26 percent increase of almost $300 more per month. More shock waves will ripple among borrowers with home equity lines that require a balloon payment; they will owe the balance in full.
Here are five steps banks should take immediately to mitigate the impending HELOC credit risk:
Take a Close Look at the HELOC Portfolio
Banks have a tendency to focus on first mortgages. But now is the time to zero in on the HELOC portfolio and conduct a thorough analysis for potential risks. Look at your borrowers’ credit history. Identify customers who are likely to default. Reach out to these individuals and make sure they know exactly what’s happening and how much they owe.
Be Proactive, not Reactive
Reach out to borrowers whose loans are nearing a reset in payment. Notify borrowers immediately if the bank is going to extend the interest rate. If the payment will jump, tell them when and by how much. Assess the borrower’s current monetary circumstances. Has there been a job layoff or loss of income in recent years? Have household expenses increased due to college tuition or the birth of another child?
Develop Loss Mitigation Programs
Explore flexible, viable alternatives to avoid defaults and reduce losses. Does the borrower have enough equity in his or her home today to refinance out of the HELOC? Develop loan modification programs aimed at HELOC consumers. Be creative and design programs that fit their current financial situations.
Given the heavy load of impending mitigation issues, it may be tough to handle everything in-house. There are several reasons why banks should consider outsourcing all or part of their mortgage and HELOC operations:
- Now more than ever, banks need to focus on their core work. Outsourcing HELOC activity will enable them to address home equity issues and allow for a continued focus on core functions.
- Regulators are encouraging banks and lenders to get ahead of the HELOC issue—a good outsource provider with experience and licenses can handle this swiftly.
- Regulatory burdens such as the SAFE Mortgage Licensing Act of 2008 and the Dodd-Frank Act of 2010 have squeezed profit margins due to rising compliance costs, making it tougher for banks to be profitable.
- Rising compliance costs and net interest margin pressure continue to impact banks as they search for ways to streamline processes and cut expenses.
Choose the Right Provider
Many bank executives worry that outsourcing will negatively affect the customer experience. Conversely, the right provider will support and strengthen banking relationships. Here are three key attributes to look for:
- Domain expertise: Find an outsourcing provider with demonstrated experience in the banking/mortgage industry. You need a provider that understands the complexities of products like HELOCs and mortgages, as well as how cycle times affect the customer experience.
- Geographical location: Particularly critical for regional banks and lenders, select a BPO with a strong onshore presence to ensure streamlined, timely service to domestic customers.
- Pricing flexibility: While the traditional Business Process Outsourcing pricing model is calculated based on the cost of employees, consider a provider that can offer transactional or outcome-based pricing, which is most beneficial for banks in terms of cost savings.
For more information on this topic, see Sutherland’s videos on “The Risks and Opportunities of Home Equity Loans” and “Mortgage Outsourcing: Benefits Beyond Cost Savings“.