5 ms·

For home loans, the collateral is the house, which is strange because the house doesn't truly belong to the borrower until the loan is paid off. Deeper still,

For home loans, the collateral is the house, which is strange because the house doesn't truly belong to the borrower until the loan is paid off. Deeper still, the conditions where home loans are risky are the same conditions where home prices are risky. In the extreme, a home buyer borrows a million dollars to buy an expensive house, the economy tanks before the first payment, the borrower walks away, and the bank gets a house worth $400K. I'm not sure the "right collateral" even exists for home loans, it's a weird case where the "collateral" is the item being purchased on credit instead of something the borrower actually has.

usrusr 6y ago
Chances are the house will be worth ten millions, but those ten millions won't be much after the global corona compensation money printing spree and the 1.x million the borrower pays will be worth nothing. The borrower being forced to walk away would be a best case outcome for the bank in a high inflation scenario.
loeg 6y ago
Banks generally don't extend HELOCs beyond a borrower's equity in the house, which is the fractional value of the house the borrower truly owns. They are basically a flexible cash-out second mortgage. > In the extreme, a home buyer borrows a million dollars to buy an expensive house, the economy tanks before the first payment, the borrower walks away, and the bank gets a house worth $400K. You've just described ordinary mortgage risk, in no-recourse states. In recourse states, the bank can go after the borrower for the remaining balance of the loan ($600k). Generally if a bank was willing to lend $1 million to someone, they had reasonably high credit and cash flow at origination time (debt-to-income ratio, non-conventional jumbo loan). They may not get their $600k back, and in no-recourse states they will get $0 back, but that is priced in to the interest rate of the loan.
- sokoloff 6y ago
  > Banks generally don't extend HELOCs beyond a borrower's equity in the house, which is the fractional value of the house the borrower truly owns. For a house worth $1MM in February and a first mortgage loan balance of $700K, it sure looks like the borrower has $300K in equity in the house. If the economy, job market, and housing market evolve such that the house becomes worth $600K a year from now, how much equity does the borrower have at that point?
  - loeg 6y ago
    What responsive argument or clarification are you trying to make with the rhetorical question about negative equity?
    - sokoloff 6y ago
      That what appears to be equity today may not be there tomorrow, which makes it sensible for banks to not lend on HELOCs up to the amount of today's (apparent) equity.
      - loeg 6y ago
        You're just describing the ordinary risk that comes with lending against collateral. Banks evaluate that risk and price it in all the time. What I think most likely happened is that banks plugged their (new, very high) risk level into their interest rate formulas, got very high rates (imagine 10-20%) and decided it would be worse, for publicity, revenue, or other reasons, to lend at those rates rather than halt HELOC origination entirely.
        sokoloff 6y ago
        It sounds like we’re agreeing with each other.
s1t5 6y ago
> For home loans, the collateral is the house, which is strange because the house doesn't truly belong to the borrower until the loan is paid off. Your thinking is circular - the house doesn't truly belong to the borrower exactly because it's the collateral of the loan. Nothing strange about it.
- throwphoton 6y ago
  It is the self-collateralization that is circular, not my thinking! Not all credit markets work like this; instead expecting as collateral something you actually own, and making margin calls when the value of that collateral falls.
jklein11 6y ago
Yes, I agree, if the borrower is overleveraged, it wouldn't very wise for a lender to make these loans. Let me throw this alternative out there. Let's say that you have a million dollar home that is paid in full(no mortgage or any other liens on the property.) You decided that given the uncertainty, you want to make sure you have a years worth of expenses in cash. The lender decides that they will lend you 100k (only 10% of the value of the home) at 2%(well above the fed rate which is near zero) as long as you agree to a lien on the property. Even if the home loses half of its value the lender will still be made whole.

usrusr 6y ago

Chances are the house will be worth ten millions, but those ten millions won't be much after the global corona compensation money printing spree and the 1.x million the borrower pays will be worth nothing. The borrower being forced to walk away would be a best case outcome for the bank in a high inflation scenario.

loeg 6y ago

Banks generally don't extend HELOCs beyond a borrower's equity in the house, which is the fractional value of the house the borrower truly owns. They are basically a flexible cash-out second mortgage. > In the extreme, a home buyer borrows a million dollars to buy an expensive house, the economy tanks before the first payment, the borrower walks away, and the bank gets a house worth $400K. You've just described ordinary mortgage risk, in no-recourse states. In recourse states, the bank can go after the borrower for the remaining balance of the loan ($600k). Generally if a bank was willing to lend $1 million to someone, they had reasonably high credit and cash flow at origination time (debt-to-income ratio, non-conventional jumbo loan). They may not get their $600k back, and in no-recourse states they will get $0 back, but that is priced in to the interest rate of the loan.

sokoloff 6y ago
> Banks generally don't extend HELOCs beyond a borrower's equity in the house, which is the fractional value of the house the borrower truly owns. For a house worth $1MM in February and a first mortgage loan balance of $700K, it sure looks like the borrower has $300K in equity in the house. If the economy, job market, and housing market evolve such that the house becomes worth $600K a year from now, how much equity does the borrower have at that point?
- loeg 6y ago
  What responsive argument or clarification are you trying to make with the rhetorical question about negative equity?
  - sokoloff 6y ago
    That what appears to be equity today may not be there tomorrow, which makes it sensible for banks to not lend on HELOCs up to the amount of today's (apparent) equity.
    - loeg 6y ago
      You're just describing the ordinary risk that comes with lending against collateral. Banks evaluate that risk and price it in all the time. What I think most likely happened is that banks plugged their (new, very high) risk level into their interest rate formulas, got very high rates (imagine 10-20%) and decided it would be worse, for publicity, revenue, or other reasons, to lend at those rates rather than halt HELOC origination entirely.
      - sokoloff 6y ago
        It sounds like we’re agreeing with each other.

s1t5 6y ago

> For home loans, the collateral is the house, which is strange because the house doesn't truly belong to the borrower until the loan is paid off. Your thinking is circular - the house doesn't truly belong to the borrower exactly because it's the collateral of the loan. Nothing strange about it.

throwphoton 6y ago
It is the self-collateralization that is circular, not my thinking! Not all credit markets work like this; instead expecting as collateral something you actually own, and making margin calls when the value of that collateral falls.

jklein11 6y ago

Yes, I agree, if the borrower is overleveraged, it wouldn't very wise for a lender to make these loans. Let me throw this alternative out there. Let's say that you have a million dollar home that is paid in full(no mortgage or any other liens on the property.) You decided that given the uncertainty, you want to make sure you have a years worth of expenses in cash. The lender decides that they will lend you 100k (only 10% of the value of the home) at 2%(well above the fed rate which is near zero) as long as you agree to a lien on the property. Even if the home loses half of its value the lender will still be made whole.