HELOC and 80/20 Mortgages in the US

The next stage in the US mortgage crisis is starting to raise its head.

First of all, we have the 80/20 mortgages. In short, this is a form of 100% financing of which 80% is with the prime lender and 20% is with the second lender at a higher interest rate. These are not subprime, they can be for the Alt-A(good credit rating)and better mortgages allowing people to lend with 0% finance. The problem arises when houses are sold at a loss or foreclosed as the prime lender has first claim on the amounts owed. Write downs for this sector have yet to take place.

Then comes the Home Equity Line of Credit (HELOC). This is where people have released equity in their houses to fund their lifestyle. It has been a big factor in the excess spending in the US. Again, when houses are sold at a loss or foreclosed, there's a big problem for these lenders. Being the third in line to 80/20, there is the potential that these lenders could see a return of zero.

Americans owe a staggering $1.1 trillion on home equity loans and in December 2007, 5.7% of home equity lines of credit were delinquent or in default. What if this number was to rise to 10% in a recession? That's another $110,000,000,000 to write down.

Some more reading.

With the 80/20 (and low interest rates), we saw the basic idea of saving & investing to purchase a house go out the window. People were encouraged to spend rather than save as they could always release equity, with the HELOC, in their rapidly appreciating home to spend more or meet debt payments when needed. This involved fictitious capital being injected into the economy at huge rates. As the various Central Banks tried to correct excessive spending by raising rates, delinquencies and foreclosures rose thus causing the banks to tighten lending procedures and incur write downs. There are further write downs to come and we won't see the end of this until the reset button is pushed and everything is marked to market.