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The Coming Borrowing Crunch
All property investors need to be aware of a potential disaster in the next several years that could make obtaining mortgage funds increasingly difficult. Lenders may find themselves in such a downward spiral of red ink, that the current credit crunch will pale in comparison to what lies ahead. And what would the cause of this downward spiral be? None other than the simple home equity line of credit. A line of credit that I have consistently advocated here as a solid way to raise funds for increased property buying opportunities, as well as leverage, with some of the lowest interest rates and best terms available.
A recent article from Reuters (“Insight: A New Wave of U.S. mortgage trouble threatens,” by Peter Rudegeair, 11/26/13) notes the coming potential for disaster striking the U.S. banking industry: “U.S. borrowers are increasingly missing payments on home equity lines of credit they took out during the housing bubble, a trend that could deal another blow to the country’s biggest banks.” The article goes on to explain that “the loans are a problem now because an increasing number are hitting their 10-year anniversary, at which point borrowers usually must start paying down the principal on the loans as well as the interest they had been paying all along. More than $221 billion of these loans at the largest banks will hit this mark over the next four years, about 40 percent of the home equity lines of credit now outstanding.”
The chilling effect on property investors
If, as experts are predicting, default rates go up, even a small amount, on the vast majority of home equity lines as they hit their 10 year re-set years, and the monthly repayment nut goes up substantially because of the double-whammy of adding principal to the payment, as well as anticipated higher interest rates being rolled in beginning in 2015, the overall repayment amount may be unaffordable to many who took out their equity lines. Banks holding these second mortgage loans may not be able to recoup the losses in any default because the first mortgage would need to be paid of first, and the lender holding the equity second mortgage may not see a dime in any default scenario. Now, maybe the housing market will increase its robust performance of late. But I wouldn’t bet on it.
Over the next several years, as these equity line 10 year anniversaries roll out, and many are defaulted on, lenders will need to hunker down even more – and will curtail their lending – not only of equity loans, but first mortgages as well. Overall, credit will become increasingly tighter. Not overnight…but much like stepping in quicksand, slowly, and over several years credit markets will begin to tighten up even more.
Just how bad could things get?
The Reuters article also points out just how bad things could get: “What is happening with home equity lines of credit illustrates how the mortgage bubble that formed in the years before the financial crisis is still hurting banks, even seven years after it burst. By many measures the mortgage market has yet to recover: The federal government still backs nine out of every ten home loans, 4.6 million foreclosures have been completed, and borrowers with excellent credit scores are still being denied loans.
The only way banks would have to alleviate the stress on the system would be to take proactive measures. The Reuters article goes on to explain: “Banks have some options for reducing their losses. They can encourage borrowers to sign up for a workout program if they will not be able to make their payments. In some cases, they can change the terms of the lines of credit to allow borrowers to pay only interest on their loans for a longer period, or to take longer to repay principal.”
A return to cash as king
Ultimately, like in the last several years, cash investors will rule. Be aware of this as you plan your long-term acquisition strategy. The belt-tightening by lenders will come slowly, as more equity lines go into default when they hit their respective 10 year anniversary re-sets. Like a python squeezing it’s victims to death, property investors need to know that they too can be squeezed out of mortgage opportunities in the coming years.
photos courtesy of propertymanagersandiego.com, money.cnn.com, moneylicious.org, psdgraphics.com, infrawindow.com, mathforgrownups.com