Home Equity Crisis: Banks That Dodged Subprime Bullet Still Face Loss
According to BusinessWeek's Mar Der Hovanesian (1/28/08), home-equity lending is another big problem lurking behind the subprime mess. Previously rising property values and housing prices enabled subprime borrowers to tap into equity on their properties to finance the purchase of necessities and perhaps even luxuries. When housing market prices plunged, the business of home-equity lending soured. By the end of September 2007, at least $14.7 billion in home equity loans and lines of credit were delinquent.
Until recently, the majority of home equity lending was issued in the form of lines of credit. Home equity loans allowed borrowers to convert their equity into cash to pay down credit-card and other debt. As the boom mushroomed and housing prices soared, banks started offering piggyback loans, enabling subprime buyers to finance down payments on houses they could not afford.
According to the industry newsletter Inside Mortgage Finance, traditional underwriting standards were ignored as buyers borrowed more than the value of their homes causing nontraditional lending to soar to 14.4% of the home-equity market in 2006.
The dramatic drop in housing prices started wiping out the value of many subprime loans. For example, a buyer looking to purchase a home for $300,000 took out a primary mortgage for $240,000 and a piggyback loan for $60,000 to cover the down payment. If the price of the house decreased by 20%, the equity diminishes to zero.
A lender on a mortgage has the first claim on the underlying property. In the case of foreclosure, it can sell the property and recoup something. The bank with the home-equity piece has no such collateral and usually has to forfeit the money. Hence the predicted damage to banks with any substantial home equity exposure to subprime buyers/borrowers.
