The Wall Street Journal broke the story that Wells Fargo last November had begun requiring most of its customers to start paying principal – not just interest – on their home equity lines of credit (HELOCs).
This prompts three questions: First, what took the financial press so long to find this out? Second, what took Wells, the biggest residential mortgage and home equity lender in the country, so long to do this?
And third, why did the bank feel that it had to keep such a good and long overdue idea such a big secret?
The collapse of the housing bubble was devastating to the HELOC business, previously a fast-growing, low-risk, highly profitable business for the vast majority of retail banks and credit unions who offer the product. But since the peak year of 2009, lines of credit outstanding have dropped 26%, from $714 billion to $526 billion in the first quarter of this year, according to the Federal Reserve.
Even worse, lenders have lost billions on soured HELOCs they’ve had to write off. The delinquency rate on HELOCs stood at 3.37% at the end of the first quarter, down from 4.69% at the peak in early 2012 but still more than 10 times the 0.37% rate in 2003, before the housing bubble burst.
HELOCs used to be one of the safest consumer loans banks made, with delinquency rates well below 1% industry wide. But that figure skyrocketed during the recession as lenders made loans in anticipation of continued high home prices.
That was the same bet millions of homeowners made, taking out bigger and bigger HELOCs to build swimming pools, borrow more on their credit cards, and make additions to their homes they didn’t really need. The banks should have known better, of course, but they didn’t.
Until Wells made its historic move, the vast majority of HELOC borrowers have only been required to make interest-only payments for the first 10 years, during which time they can continue to draw down their lines, up to their maximum. Starting in year 11, but only then, borrowers are required to start making principal payments, too. Before then, of course, borrowers had the option of making principal payments.
When the housing market crashed, too many homeowners couldn’t make those higher principal payments.
It’s not clear yet how many lenders will follow Wells’ lead, although two of the banks’ biggest national competitors, Bank of America and J.P. Morgan Chase, have said they’re considering it. But other smaller lenders say they will continue to offer I-O HELOCs for the first 10 years to differentiate themselves from Wells.
For example, Navy Federal Credit Union, the nation’s largest credit union, says it has no plans to change or eliminate its I-O options on both its fixed-rate home equity loans and HELOCs, although it acknowledges that only a “small percentage” of its members choose interest-only loans.
It’s not like Wells has priced itself out of the market by demanding principal payments from day one instead of 10 years out. Typical monthly payments for most Wells HELOC customers will rise, of course, but not as much as you might think. For example, the interest-only payment on a $30,000 HELOC at the current 4.875% APR would be about $121. A fully amortizing payment including principal would be $158.83, a difference of less than $40 a month.
However, by doing so, the homeowner will pay off his loan and build equity in his home faster, or free up more equity to borrow against.
It’s clearly a more borrower- as well as lender-friendly idea. You have to wonder why it’s taken this long for a lender to make the move.
Yet while Wells is making this more responsible change, both for itself and its customers, a growing number of lenders are once again starting to make HELOCs up to 100% of the value of the property, one of the main reasons for the collapse of the housing bubble and the demise of the HELOC product.
Proving once again: Too many people in the mortgage business just never learn from their mistakes. It’s good to know that at least one lender has, if a few years late.
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