Banks warned of Home Equity Loan Risks

By Sari R. Updated on 10/25/2012

Borrowers often use their home equity as loan collateral (home equity lines of credit).  This collateral is often used for home improvements, medical bills or education.  Funds can be borrowed from home equity lines of credit during a draw period consisting of five to ten years.  During this draw period, borrowers often pay a monthly payment with zero interest or interest-only on the loan.  The entire principal amount is due at the draw period’s end according to a loan amortization schedule, a lump-sum payment, or at whatever current rate is listed in the contract.

Analysts have realized that borrowers might not be able to adequately make payments as payments increase and draw periods reach an end.  This is a risk that many borrowers have not yet taken into account.  Banks are currently being asked to address the risk for the loss of loan and lease.

Larger banks have been facing profitability challenges that come from paying the costs associated with mortgage servicing and underwriting deficiencies.  Banks that are competing for lending prospects are also seeing new and unique risks as they have entered unfamiliar revenue streams such as gas and oil lending. 

Another concern for analysts is the fact that bank revenue has been increasing as a result of provision reductions for loan-losses.  This can largely be attributed to credit quality improving, but analysts are concerned because reserve releases isn’t a sustainable measure of growth for banks.  Macroeconomic issues are also of risk for banks since the nation’s economy is currently growing at a slow rate.  Domestic loan demand has increased, but bigger gains in this industry will depend on a continuous economic growth.