A home equity loan that puts the total debt on a home over that level can be especially risky for the lender. That's because if the property goes into foreclosure, Cecala said, "All the money goes to pay off the first mortgage holder."
In fact, in cases of foreclosure, home equity loans are being sold to adventurous investors for as little as 3% of the amount of the loan, said Paul Muolo, data editor for National Mortgage News.
Many lenders, including Citigroup Inc. and JPMorgan, reported lower fourth-quarter earnings because of losses on home equity credit lines.
San Francisco-based Wells Fargo & Co., which avoided many of the costly mistakes in mortgage securities and sub-prime loans that have plagued rivals, just added $1.4 billion to its provision for loan losses, mainly on home equity loans.
Wells Fargo executives "did not fully appreciate the severity of the residential real estate downturn and its impact on our home-equity portfolio," Mike Loughlin, chief credit officer at Wells, said in a statement this month. Representatives of Wells Fargo declined Thursday to talk about its problems with home equity loans.
Some small lenders also have been forced to change their policies in response to the downturn in home prices. Cityside Federal Credit Union in downtown Los Angeles, which has 6,482 members and $53 million in assets, has cut its maximum loan-to-value ratio to 90% from 100% and is rejecting many requests from members who had hoped to refinance mortgages at today's low rates.
"A lot of people are in that situation right now because they just kept refinancing and took out all the equity in their homes," said Teresa Becerra, a loan officer at Cityside. "They'll have a couple of mortgages they want to combine now. But we can do a computer appraisal right away, and what they're finding out is that the value just isn't there."
Cityside has had to cut off some home equity lines of credit as well as turn down borrowers seeking new loans because of the change, Becerra said. So far it has cut off credit only when customers brought up issues that caused the credit union to examine their circumstances.
"If they had home equity, and now they're upside down and it's brought to our attention, we'll definitely cut them off," she said. "But we're not doing a computer-generated study to find all those situations or anything like that."
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