End of the Line: Behavior of HELOC Borrowers Facing Payment Changes

An important question in the household finance literature is whether a change in required debt payments affects borrower behavior. One challenge in this literature has been identifying whether higher default rates observed after an increase in debt payments stem from the inability of borrowers to pay the higher amount, or the attrition of better borrowers in advance of the payment change. A related question is whether the higher default rate is a result of specific features of the debt product, or the type of borrower who chooses the product. We address both of these questions as they relate to a scheduled increase in payments on home equity lines of credit (HELOCs). Many existing HELOCs are structured such that when they reach the end of the draw period, they convert from open-ended, non-amortizing lines of credit to closed-end, amortizing loans. We compare the performance of HELOCs reaching end of draw with those not reaching end of draw and find that HELOCs that reach end of draw have a significantly higher cumulative default rate in the following months. We also show that, at end of draw, borrowers who have a HELOC with a balloon feature are more likely to have lower credit scores and higher LTVs than borrowers who have HELOCs with longer amortization periods. However, even controlling for borrower and loan characteristics, HELOCs with a balloon payment are more likely to default. This result provides evidence that HELOC defaults can be influenced both by the features of the product and the characteristics of borrowers who choose those features.