Debts Rise, and Go Unpaid, as Bust Erodes Home Equity

PHOENIX — During the great housing boom, homeowners nationwide borrowed a trillion dollars from banks, using the soaring value of their houses as security. Now the money has been spent and struggling borrowers are unable or unwilling to pay it back.

The delinquency rate on home equity loans is higher than all other types of consumer loans, including auto loans, boat loans, personal loans and even bank cards like Visa and MasterCard, according to the American Bankers Association.

Lenders say they are trying to recover some of that money but their success has been limited, in part because so many borrowers threaten bankruptcy and because the value of the homes, the collateral backing the loans, has often disappeared.

The result is one of the paradoxes of the recession: the more money you borrowed, the less likely you will have to pay up.

“When houses were doubling in value, mom and pop making $80,000 a year were taking out $300,000 home equity loans for new cars and boats,” said Christopher A. Combs, a real estate lawyer here, where the problem is especially pronounced. “Their chances are pretty good of walking away and not having the bank collect.”

Lenders wrote off as uncollectible $11.1 billion in home equity loans and $19.9 billion in home equity lines of credit in 2009, more than they wrote off on primary mortgages, government data shows. So far this year, the trend is the same, with combined write-offs of $7.88 billion in the first quarter.

Even when a lender forces a borrower to settle through legal action, it can rarely extract more than 10 cents on the dollar. “People got 90 cents for free,” Mr. Combs said. “It rewards immorality, to some extent.”

Utah Loan Servicing is a debt collector that buys home equity loans from lenders. Clark Terry, the chief executive, says he does not pay more than $500 for a loan, regardless of how big it is.

“Anything over $15,000 to $20,000 is not collectible,” Mr. Terry said. “Americans seem to believe that anything they can get away with is O.K.”

But the borrowers argue that they are simply rebuilding their ravaged lives. Many also say that the banks were predatory, or at least indiscriminate, in making loans, and nevertheless were bailed out by the federal government. Finally, they point to their trump card: they say will declare bankruptcy if a settlement is not on favorable terms.

“I am not going to be a slave to the bank,” said Shawn Schlegel, a real estate agent who is in default on a $94,873 home equity loan. His lender obtained a court order garnishing his wages, but that was 18 months ago. Mr. Schlegel, 38, has not heard from the lender since. “The case is sitting stagnant,” he said. “Maybe it will just go away.”

Mr. Schlegel’s tale is similar to many others who got caught up in the boom: He came to Arizona in 2003 and quickly accumulated three houses and some land. Each deal financed the next. “I was taught in real estate that you use your leverage to grow. I never dreamed the properties would go from $265,000 to $65,000.”

Apparently neither did one of his lenders, the Desert Schools Federal Credit Union, which gave him a home equity loan secured by, the contract states, the “security interest in your dwelling or other real property.”

Desert Schools, the largest credit union in Arizona, increased its allowance for loan losses of all types by 926 percent in the last two years. It declined to comment.

The amount of bad home equity loan business during the boom is incalculable and in retrospect inexplicable, housing experts say. Most of the debt is still on the books of the lenders, which include Bank of America, Citigroup and JPMorgan Chase.

“No one had ever seen a national real estate bubble,” said Keith Leggett, a senior economist with the American Bankers Association. “We would love to change history so more conservative underwriting practices were put in place.”

The delinquency rate on home equity loans was 4.12 percent in the first quarter, down slightly from the fourth quarter of 2009, when it was the highest in 26 years of such record keeping. Borrowers who default can expect damage to their creditworthiness and in some cases tax consequences.

Nevertheless, Mr. Leggett said, “more than a sliver” of the debt will never be repaid.

Eric Hairston plans to be among this group. During the boom, he bought as an investment a three-apartment property in Hoboken, N.J. At the peak, when the building was worth as much as $1.5 million, he took out a $190,000 home equity loan.

Mr. Hairston, who worked in the technology department of the investment bank Lehman Brothers, invested in a Northern California pizza catering company. When real estate cratered, Mr. Hairston went into default.

The building was sold this spring for $750,000. Only a small slice went to the home equity lender, which reserved the right to come after Mr. Hairston for the rest of what it was owed.

Mr. Hairston, who now works for the pizza company, has not heard again from his lender.

Since the lender made a bad loan, Mr. Hairston argues, a 10 percent settlement would be reasonable. “It’s not the homeowner’s fault that the value of the collateral drops,” he said.

Marc McCain, a Phoenix lawyer, has been retained by about 300 new clients in the last year, many of whom were planning to walk away from properties they could afford but wanted to be rid of — strategic defaulters. On top of their unpaid mortgage obligations, they had home equity loans of $50,000 to $150,000.

Fewer than 5 percent of these clients said they would continue paying their home equity loan no matter what. Ten percent intend to negotiate a short sale on their house, where the holders of the primary mortgage and the home equity loan agree to accept less than what they are owed. In such deals primary mortgage holders get paid first.

The other 85 percent said they would default and worry about the debt only if and when they were forced to, Mr. McCain said.

“People want to have some green pastures in front of them,” said Mr. McCain, who recently negotiated a couple’s $75,000 home equity debt into a $3,500 settlement. “It’s come to the point where morality is no longer an issue.”

Darin Bolton, a software engineer, defaulted on the loans for his house in a Chicago suburb last year because “we felt we were just tossing our money into a hole.” This spring, he moved into a rental a few blocks away.

“I’m kind of banking on there being too many of us for the lenders to pursue,” he said. “There is strength in numbers.”