End-of-Draw Performance Not as Bad as Feared

One effect of the rapid increase in home prices from 2000 to 2006 was the increased use of home equity lines of credit (HELOCs) as a method for homeowners to extract equity from their properties. HELOCs consist of a “draw period” and a “post-draw period.”  At any time during the draw period, borrowers can borrow up to a specified credit limit, or pay part or all of the outstanding balance.  During this period, borrowers are only required to pay interest on outstanding balances.  When the draw period ends, most HELOC loan structures change to an amortizing loan, requiring the borrower to pay a fixed amount each month based on the outstanding balance at the end of draw period.  The monthly payment of HELOC borrowers having a positive balance at the end of draw period may rise, increasing the risk of loan delinquency and/or default.

The CoreLogic loan-level home equity database is used to examine HELOC performance near the end of the draw period for HELOCs originated from 2003 to 2007.[1]  Since HELOCs exhibit some variation in the length of the draw period, we focus on a common length of 10 years. 

A substantial number of HELOC borrowers pay off and close their loans years before the end of draw period. Between 50 and 70 percent of the 2003-2007 cohort accounts are closed before reaching four years prior to the end of draw.  These borrowers have zero risk of being impacted by payment shock at the end of draw period.  For the analysis, CoreLogic selected HELOCs that are still open four years prior to the end of draw term[2] in order to focus on loans that may be at risk for delinquency and/or default by the end of draw period.

Figure 1 illustrates the percent of loans that were not closed six years after origination and remain open in subsequent months. There is little variation across the 2003-2007 origination cohorts, with about 60 percent of loans remaining open by the end of draw.  Even when limiting the data to loans that remained open four years prior to the end of draw, a substantial percent of these loans close before reaching the end of draw.

There is an increase in loans closed near the end of draw (10 years after origination), as loans are typically paid off and close or, to a lesser degree, become delinquent and/or in default.

Figure 2 illustrates the cumulative default[3] rates across the 2003-2007 vintages for loans that were not closed at six years after origination.  CoreLogic data show there is a consistent increase in cumulative default upon reaching the end of draw period.  However, even when expressed as the percent of loans that were active four years prior to the end of draw, the uptick in default at the end of draw is not large—about 50 basis points. Additionally, the 2007 cohort exhibits substantially lower cumulative default rates than the 2005 and 2006 cohorts.

The decline in home prices after 2007 and the potential for rising interest rates resulted in a fear that a substantial number of HELOC borrowers would default on the loans upon reaching the end of their draw period. Rising interest rates could increase the payment shock at the end of draw period, while a loss of home equity could trap borrowers in loans.  However, robust home price appreciation in recent years and continued low interest rates have mitigated default risks for recent cohorts reaching the end of draw.  As a result, a substantial negative impact of the end of draw period on HELOC performance has not materialized.

[1] HELOC originations decreased significantly in 2008 and onward, when lending conditions tightened.

[2] For HELOCs having a 10-year draw period, four years prior to the end of draw corresponds to six years after the loan origination.

[3] Default is defined as 90+ days past due.

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