Wells Fargo Won’t Accept HELOC Applications – Will Credit Continue To Tighten?

Wells fargo (NYSE: WFC) announced Thursday that it will no longer accept applications for a Home Equity Line of Credit, or HELOC.

This is the latest move by a major US financial institution to tighten mortgage lending practices. JPMorgan Chase (NYSE: JPM) previously announced that it would stop approving new HELOCs and also announced stricter credit standards for new mortgage customers.

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It is hardly surprising. Recessions tend to lead to an increase in defaults, and borrowers with lower credit levels tend to be more in default during tough times. In response to economic downturns, it is not uncommon for banks to pull out of loans they perceive to be risky. We said this during the 2008-09 financial crisis, and for several years afterwards.

Why are banks withdrawing from HELOCs?

A home equity line of credit, or HELOC, allows a homeowner to obtain a line of credit backed by the equity in their home. If a lender uses an 80% loan-to-value ratio (the most common) and you owe $ 100,000 on a home worth $ 200,000, you may be able to get a HELOC for up to 60,000. $. ($ 160,000 is 80% of $ 200,000).

From a bank’s perspective, a HELOC is a much riskier loan than a mortgage, even for borrowers with prime credit standards.

The reason? A HELOC is in second position. If a borrower does not pay off their mortgage and HELOC and the house is foreclosed, the mortgage lender has to get back the money owed to them before the HELOC lender can get anything. In a market where house prices could potentially fall (like a deep recession), it becomes a real possibility that a HELOC lender will end up with a big loss.

To be clear, Wells Fargo and JPMorgan Chase continue to provide cash refinance loans, which also allow borrowers to leverage their equity. But for the foreseeable future, it looks like HELOCs will be harder and harder to find.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are motley! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.

Alice P. Darby