Do you do an annual review of HELOC portfolio?
Our topic today is the need for an annual review of your HELOC portfolio, something regulators expect to see.
Thank you for tuning in on Christmas Eve. My colleague Colin got a good laugh out of the office yesterday by noting that my weekly newsletter readership is likely to drop by 50% if my parents are going to be on vacation (That's a good one, the first time I heard that I laughed so hard I fell off my dinosaur).
Recently, we've heard of at least one New England lender criticized for failing to review its HELOC portfolio on an annual basis. Obviously, we expect home equity lending to continue to be a "bright spot" (and especially when rates eventually rise - borrowers not giving up their primary mortgages, which are locked in at super low rates). Therefore, we thought this would be a good, quick note.
Annual Review of HELOC Portfolio
Once a year, you should have someone review the HELOC portfolio to determine whether lines should be continued based on any changes to the borrower's financial condition.
This is encouraged by interagency guidance (FDIC, NCUA, OTC, the Fed, OCC) available at Credit Risk Management Guidance for Home Equity Lending.
Reg. Z Limitations
As part of your annual review, let's assume that you identify 5 lines where you think it is best to either (a) freeze additional credit or merely (b) reduce the credit limit. But Note: You can't just simply take action as you please; there are limitations!
There are three circumstances where you're allowed to freeze future credit extensions or reduce the credit limit. In other words, you can only take action on the 5 loans you identified in your annual review where at least one of the three tests applies:
The value of the dwelling declines "significantly" below appraised value
There is a "material default" by the borrower
There is a "material change" in the borrower's financial circumstances such that you can reasonably determine that the borrower will be unable to fulfill his/her obligations to repay extensions of credit
Note: Technically, there are a couple more, but these three are the most basic ones. The applicable rule is 12 CFR 1026.40.
Here are some additional notes that may be helpful in applying these three tests:
What is a "significant" decline? While you may get away with less, there's a safe harbor here if the dwelling drops in value such that the difference between the initial credit limit and available equity drops by 50% or more. For example, assume the HELOC was closed with an appraised value = $200,000, 1st mortgage = $150,000, line of credit = $20,000, available equity therefore = $30,000. Two years later, the property value has dropped to $175,000, this leaves (using the original numbers), available equity of $15,000, which is 50% of the original available equity, and therefore is considered a "significant" decline under this rule.
What would be a "material default" by the borrower? Look into this further, but some examples might be the borrower moving to a different residence, or not paying taxes so as to risk giving the government a superior lien.
What is a "material change" in financial circumstances? Bankruptcy is a good example, just to name one.
You're allowed to freeze/reduce credit only while one of these three circumstances exists. If the circumstance ceases to exist, you must lift the prohibition/reduction. For example, if you freeze a credit line on a borrower who has lost her job. You would have to un-freeze (melt?) the line if she started a new job with a comparable salary.
In other news:
If you haven't already, becoming comfortable with the appraisal rules from Dodd-Frank (that will replace the HVCC and 2008 Rule) is a good idea. Currently, an interim rule from the Federal Reserve rules the land (until final rules are proposed and finalized). In some ways, the new Dodd-Frank rule is expected to be broader than the previous; for example, it will apply to HELOCs (no longer just closed-end loans) and is expected to be applied to valuations (and not only formal "appraisals"). Here's an article that hits some of the main points and also links to the Federal Register.
I wanted to include a joke related to North Korea's hacking of SONY (and the subsequent shutdown of internet in NK for almost half a day- accomplished either by the U.S. or a 10- year old with an iPhone 6), but we didn't want to increase our cyber-security risk level.
New to Twitter? Here are a few knowledgeable "handles" to follow to get started: @mbamortgage; @davidhstevens; @natmortgagenews; @TEDTalks; @sca_spillane (wink).
We hope everyone has a wonderful Christmas, and that you find a way to spend time with loved ones. Whether you're flying across the country, walking across the street, or "Skyping" over dinner, we hope you're with people who care about you.
"The strength of a nation derives from the integrity of the home."
- Confucius
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