Make us your home page
Instagram

Advice to stop paying on home equity line of credit risky at best

Advice to stop paying on home equity credit line is risky at best

WASHINGTON — Are you delinquent on your first mortgage but still making monthly payments on your home equity credit line or second mortgage?

If so, a finance and real estate professor from DePaul University has some controversial advice for you: Stop paying on your second immediately.

Rebel Cole thinks you are throwing good money after bad.

If you are seriously delinquent on the first mortgage, you're likely headed for foreclosure unless both of your lenders agree on a modification or principal reduction plan. But since you continue to make payments on the second, the bank that holds that revenue-producing note may have minimal motivation to participate in a workout, he believes. Cole estimates that between 1 million and 3 million homeowners are in this position nationwide — so it's a big problem.

By abruptly stopping payments, Cole said, you will force the bank that owns your second mortgage to set aside significant additional capital for loss reserves. Contrast that with that bank's current situation: It gets to report your home equity loan as "performing" for accounting purposes, requiring no extra capital allocations, he said. This is despite the fact that the delinquent first mortgage — which takes payoff priority over the second and may well be underwater — probably renders the true market value of your home equity loan around zero in any foreclosure.

Once the bank is forced to set aside additional capital — as high as 100 percent of the face amount of your equity line — "it starts to really feel pain," Cole said in an interview. Now you should find it more willing to negotiate with you and your first mortgage holder to work out a loan modification, principal reduction or short sale. And if not, simply bank the money you'd otherwise be paying on the second mortgage.

It may take a year until a foreclosure filing, and 350 days or more, depending upon your location, before you actually have to vacate the house. Meanwhile you'll be saving money every month.

Sound like a smart financial strategy? Cole has been pushing the idea in analysis and opinion articles, but what are the real pros and cons for consumers?

Start with the core idea that banks will be vulnerable to big hits to capital for loss reserves if you stop paying on your second mortgage — thereby softening them up for principal reductions later. That's not likely to happen, according to banking executives and financial regulators, because current federal loss-reserve rules already require institutions to proactively set aside additional reserves on seconds once there is any hint that the associated first mortgage is in distress — whether through delinquency, a loan modification or other indications.

Also, Cole's estimate of as many as 3 million homeowners with paid-up seconds but delinquent firsts appears to be far overstated, according to new data from the Office of the Comptroller of the Currency. Recent bank examinations found that about 235,000 second liens may be in that position — a substantial number, officials concede, but nowhere near Cole's estimate of the size of the problem.

Even more important, the personal impact on you when you stop paying a second lien could be severe. Your credit scores will definitely take a hit. Since you're behind on the first loan, your scores are probably depressed already. But stiffing the lender on your second mortgage will push them down even more, further limiting your access to credit in the future.

Worse, in some states, even if you go through foreclosure, the bank could legally pursue you for full payment on the face amount on the unpaid second. The bigger the outstanding home equity loan, the more likely the pursuit.

Asked for comment, federal financial regulators bristled at Cole's proposals. Timothy Long, senior deputy comptroller of the currency, called the professor's recommendations misguided.

"That kind of advice to borrowers is dangerous," Long said in an interview.

Top officials of major banks generally were reluctant to talk on the record about Cole's ideas, but Dan Frahm, a Bank of America spokesman, said his company's "approach has been not to let second lien issues prevent us from modifying" mortgages, including "making principal reductions, even when the second lien is owned by a third-party investor and has not been modified." The bank also said stopping payment on a second would not enhance a borrower's chances of a modification or principal reduction.

Bottom line: Follow professor Cole's advice at your own peril. There is little evidence it will be effective in convincing your lender to do anything.

Ken Harney can be reached at kenharney@earthlink.net.

Advice to stop paying on home equity line of credit risky at best 09/24/10 [Last modified: Friday, September 24, 2010 4:30am]
Photo reprints | Article reprints

Copyright: For copyright information, please check with the distributor of this item, Special to the Times.
    

Join the discussion: Click to view comments, add yours

Loading...
  1. Apple Scales Back Its Ambitions for a Self-Driving Car

    Autos

    SAN FRANCISCO — As new employees were brought into Apple's secret effort to create a self-driving car a few years ago, managers told them that they were working on the company's next big thing: A product that would take on Detroit and disrupt the automobile industry.

     In this Monday, April 10, 2017 file photo, Luminar CEO Austin Russell monitors a 3D lidar map on a demonstration drive in San Francisco. Russell, now 22, was barely old enough to drive when he set out to create a safer navigation system for robot-controlled cars. His ambitions are about to be tested five years after he co-founded Luminar Technologies, a Silicon Valley startup trying to steer the rapidly expanding self-driving car industry in a new direction. Apple says it will scale back its amitions to build a self-driving car.  [AP Photo/Ben Margot]
  2. Groundbreaking today for complex on old Tampa Tribune site

    Real Estate

    TAMPA — A groundbreaking is slated for 10 a.m. today for a 400-unit apartment complex planned on the site of the former Tampa Tribune building in downtown Tampa.

    Renderings for a high-end apartment complex that will be built on the Tampa Tribune site in downtown Tampa. 
[Courtesy of Related Group]
  3. Walmart announces delivery partnership with Google

    Retail

    Walmart announced a new delivery partnership with Google to make online shopping easier for customers.

    People walk in and out of a Walmart store in Dallas. Walmart announced a new delivery partnership with Google.  [Associated Press]
  4. Insurance regulators fret over a spike in auto glass claims

    Banking

    TALLAHASSEE — Three months ago, state regulators weren't tracking a surge in broken auto glass claims, particularly in Tampa Bay.

    The issue has their attention now.

    The Office of Insurance Regulation is taking on assignment of benefits abuse in the 2018 legislative session. Pictured is Florida Insurance Commissioner David Altmaier. | [Times file photo]
  5. Proino Breakfast Club owner charged with not paying state taxes

    Crime

    LARGO — Just before noon on a recent Sunday at Proino Breakfast Club, the dining room was bustling as owner George Soulellis chatted with a customer.

    Proino Breakfast Club at 201 West Bay Drive in Largo. The owner was arrested last month on a theft of state funds charge, according to court records. JIM DAMASKE   |   Times