A HELOC is quite similar to a business line of credit and has some similarities to a consumer credit card as well. Using the residence as security, a homeowner is given a line of credit with a prescribed limit upon which the borrower can draw at any time.
Because qualifying standards were based primarily on the equity in the home, HELOCs became nearly irresistible in those states where prices were rising rapidly in 2004-2005. Homeowners discovered that their home had actually become a money tree which they could shake almost at will.
Well, no. Homeowners were sold the presence of that "money tree" and its attributes. You do recall the advertising, right? I sure do.
And what did people do? Exactly what the banks told them was a good idea to do in their advertising. The referenced article points out one particularly-obscene example:
On 3/11/2004 the wife appears alone on title, and the first mortgage is $999,800.
On 8/30/2004 she refinanced with a $1,000,000 first mortgage.
On 12/28/2005 she refinanced with a $2,170,000 first mortgage.
On 2/1/2006 she got a HELOC for $250,000.
On 8/22/2006 she refinanced with an Option ARM for $2,500,000.
On 11/15/2006 she opened a HELOC for $490,000.
On 8/1/2007 she refinanced with another Option ARM for $3,225,000.
On 10/22/2007 she opened a HELOC for $500,000.
Total property debt is $3,725,000.
Total mortgage equity withdrawal is $2,725,200 during a four-year stretch."
Now granted, this is an extreme example, but blaming the homeowner alone, when the banks knew full well that there was absolutely nothing behind these loans except hot air, is disingenuous at best.
In four years this person took out nearly three million dollars of what amounts to unsecured debt. Yes, unsecured. Our authorities did not force the banks to hold reserves behind these unsecured lines and neither did anyone else.
Oh, I know, they claim it was "secured." Uh huh. Parabolic "asset valuations" predicated on a greater sucker showing up next week do not amount to security behind a loan.
Further, these loans are all unsecured in law, not just in fact, in that they are behind any first mortgage. If the first mortgage is for more than the property is worth these loans are literally signature loans with zero collateral behind them.
Yet today, to this very day, these are being held on bank balance sheets as "secured" real estate borrowings - even when the property they are associated with is worth nowhere near the full value of the mortgages.
Only 5% of these clients said they would continue paying their home equity loans no matter what. The other 85% of them said they would default on the second lien and worry about it "only if and when they were forced to."
It is truly worrisome to contemplate what could happen if this attitude continues to spread among the millions of underwater HELOC borrowers.
Those who judge that as a pure business decision they should walk away should do so.
That which the regulators will not impose as discipline on the market, most particularly the banks who made intentionally unsound loans to these people, the market should and indeed will and must eventually impose.
As I have said repeatedly in these pages, banks and other institutions, including the Mortgage Bankers Association itself, have and will default on purpose on their real estate loans when it makes business sense.
There is absolutely no reason why you, an ordinary homeowner, should do anything different.
You need competent legal, accounting tax advice before undertaking such a course of action, as those actions do have risks and costs. It may be that in your particular situation such a move does not make sense.
But there is no moral imperative to pay a debt that was contracted with inadequate disclosure, predicated on a lie (that your loan was "secured" by ever-rising real estate value at mathematically-impossible rates), and granted to you by a party that had the position of superior information - yet they made the loan anyway, knowing it was unsound.
Get that legal and accounting/tax advice and make the decision that is right for you.
Not the one that is right for the banks.
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