banktime.com

I recently read a disturbing article in the New York Times having to do with the repayment of home equity loans that were borrowed during the height of the real estate bubble that precipitated the current economic crisis. In the halcyon days of blooming real estate values, during the first part of the last decade, homeowners across America borrowed upwards of a trillion dollars in cash against the grossly inflated values of their homes. Just a few short years later, with home values in the tank, the money spent, and these same consumers exhausted from a half-decade of recession, most of these borrowers are either unable or disinclined to pay back what they technically owe.

The American Bankers Association released a statement recently announcing that delinquencies on home equity loans are soaring, having exceeded those of car/boat/other auto loans, personal loans, and credit cards issued by Visa and MasterCard. The lenders of home equity products have so far had little success in getting back the money they are owed. Why, you might ask? Well, the collateral on these loans – the value of borrowers’ homes – has evaporated like water in the desert, and many borrowers at their wits’ end are simply threatening bankruptcy rather than being compelled to repay the loans. The greater the amount of money that was borrowed, the less chance there is that banks will ever see a scant time of their cash back.

Financial experts say that it’s not at all hard to see where the crisis happened. Households making only modest incomes were allowed to withdraw triple-digit equity loans on the inflated values of their homes. Now that the market has crashed, there is precious little chance of the bank ever having the chance to collect. The damages from this trend? An estimated eleven point one billion dollars in home equity loans written off as bad debt, and an additional twenty billion in defaulted home equity lines of credit in 2009 alone. That’s more than banks wrote off in bad debt from primary mortgages gone bad, which is really saying something. This year is looking to be no better, with over seven and three-quarters billion dollars in combined write-offs going on the books during the first quarter of 2010.

Lenders are finding themselves over a barrel to do anything about this crisis, either. Efforts to exercise some legal muscle on recalcitrant borrowers have been almost pointless, considering that many borrowers dragged to court end up settling ten cents on the dollar – or even less. It’s a system that rewards unethical behavior, tut-tuts the banking industry, but it doesn’t seem likely to change any time soon. Debt collectors that scoop up home equity loans in the hopes of collecting on them in the future seldom pay more than a few hundred dollars for the loan, regardless of how high the loan happens to be. The chief executive of Utah Loan Servicing, a specific collector referenced in the NYT article, claims that any home equity loan of more than fifteen or twenty thousand dollars is likely to never be collected. Clark Terry claims that American homeowners “seem to believe that anything they can get away with is O.K.”

For their own parts, homeowners sitting on huge home equity debts with no conceivable way to repay them claim that they are simply trying to recover from unspeakably stressful financial crises and to rebuild their lives. Banks have a great deal of the blame for having extended home equity loans and lines of credit all willy-nilly, and possibly even having been predatory in their approval of middle-class homeowners for huge loans. The same consumers who happily accepted fat checks for vacation homes and other luxury items now say that they were duped by their banks, and that they are now flat broke while banks had the benefit of fat bailout amounts from the American government. At the end of the day, homeowners also hold what the article rightfully referred to as the trump card – most of them have already had their credit trashed in other ways, and they will simply declare bankruptcy and have the total debt discharged if the bank won’t give them a huge settlement break or let the loan go.

The article quoted one such homeowner, a Shawn Schlegal of Arizona. Schlegal voluntarily walked away from his home last year through a foreclosure after the value plummeted to less than a third of the mortgaged amount. He owes his bank almost ninety-five thousand dollars in a home equity loan that is currently sitting collecting dust, even after a court order for wage garnishment that has as yet yielded no action. Schlegal shamelessly admits that he is hoping the case will simply “go away.” He admits to getting seduced by the real estate bubble, scooping up three investment properties and some vacant land with dreams of becoming a small-time real estate tycoon of sorts. He used the inflated “proceeds” from each deal as a launching pad for the subsequent purchase. This chain turned into a domino effect of disaster when the market crashed. In one case, a property that Schlegal bought for two hundred sixty-five thousand dollars was worth just sixty-five thousand by the time that the dust had settled. Schlegal’s lender for one of these loans was the Desert Schools Federal Credit Union, the largest credit union in the state of Arizona. The contract for Schlegal’s loan with DSFCU states that the approval was based on a “security interest in your dwelling or other real property.” In other words, he had other properties worth money, so the loan should be okay. Right? Wrong. The credit union has been forced to up its budgetary allowance for all losses by a phenomenal nine hundred twenty-six percent in the last two years. That comes of dumb decisions like approving the unrepentant Schlegal for a loan that he should never have qualified for.

The article quoted Keith Legget, a “senior economist” with the American Bankers Association, as grieving the fact that “more conservative underwriting practices” were not put into place a lot sooner. He blames the fact that “no one had ever seen a national real estate bubble” on why the banks engaged in such freewheeling lending. Now, the fallout damage from the collapse of the home equity loan bubble is way too huge in scope to even be accurately quantified. In retrospect, it all looks incredibly heedless and stupid. A vast amount of the outstanding debt from these loans gone bad remains on the books of the country’s largest lenders, which include Bank of America, Citigroup and JPMorgan Chase. Home equity loan repayment delinquencies ran around four and one-tenth percent in the first quarter of this year, which represents a slight decrease from Q4 2009’s all-time record-setting percentage.

Homeowners who turn their backs on the home equity loans are not free of penalties, of course. Severe damage to credit scores and a possible hit at income tax time (since debt written off can be recorded as income) are just two possible consequences of defaulting on such an obligation. That hasn’t stopped many homeowners, however. Another example of a home equity loan borrower defaulting is Eric Hairston, an erstwhile apartment owners and property manager who took a fifty percent hit on the three-unit building that he bought in Hoboken, New Jersey at the apex of the real estate boom. This spring, the property sold for seven hundred fifty thousand dollars – exactly half of the one-point-five million that it was appraised at during the peak of the market. Based on this inflated value, Hairston borrowed one hundred ninety thousand dollars in home equity loans. Hairston, who works as a technology consultant for i-banker Lehman Brothers, used his bounty to invest in a pizza catering company in the state of California. Like so many start-up ventures launched during that time, the pizza joint flopped. His investment failed, so Hairston defaulted. He has yet to hear from his lender, but stated to a reporter that he believed a ten percent settlement would be reasonable. His justification is that “it’s not the homeowner’s fault that the value of the collateral drops.”

This is a commonly-held belief nowadays. The Times also interviewed Marc McCain, a lawyer in the city of Phoenix, Arizona, who has made three hundred new clients in the past year by helping distressed homeowners execute strategic defaults on their homes. In case you are unfamiliar with the term, this refers to homeowners who are technically able to pay their mortgage, but choose not to because they believe their investment is shot and that they are throwing away money on a property that is worth nothing like the value at which it is mortgaged. McCain states that his average client is also dragging around unpaid home equity loans of anywhere from fifty thousand to one hundred fifty thousand dollars. He estimates that a full eighty-five percent of his clients are fully willing to default on the loan and to back-burner the remaining obligation, troubling themselves with the balance “only if and when they were forced to.” Ten percent of the clients are in the process of negotiating a short sale on their homes, through which they will broker a deal with their primary mortgage and home equity loan lenders to sell the house for less than what is owed in exchange for everyone involved being able to unload the house and move on. Of course, primary mortgage holders get paid first in these deals, so home equity lenders still get shafted. Only five percent or less of McCain’s clients state that they intend to continue paying their obligation on the loans no matter what happens.

McCain has no shame in admitting that he recently negotiated one couple’s massive seventy-five thousand dollar home equity obligation down to a settlement of just thirty-five hundred dollars – less than five percent of the original amount owed. He says that morality is “no longer an issue” in these cases.

The final person in the article, Darin Bolton, seemed to imply that morality should not be an issue, either. He claimed that a feeling of “tossing [his family’s] money into a hole” was what spurred him to say goodbye to his cumbersome mortgage and home equity loans in favor of a comparable rental property just blocks away from the home he gave up. Bolton optimistically opined that he believed there is “strength in numbers,” and that there may just be way too many delinquent home equity borrowers for banks to chase them all. Great news for Bolton, bad news for banks.