Property Tax Monitoring and Management Can Mitigate Increasing Default Risk in Home Equity Lending

Among the many unexpected outcomes of the pandemic-induced real estate boom was the growth of home equity lending, fueled by low interest rates and robust home price increases that resulted in record equity among homeowners. As people sheltered in place and shifted to remote work, that spurred an increase in home equity-funded expansions and upgrades for both existing homeowners and those who purchased a home. In addition, the super competitive seller’s market meant sellers didn’t have to make repairs, further adding to the demand for home equity lending as new homeowners sought to fix these repairs and add their own upgrades.

The market’s response to the increased demand for home equity lending was robust with larger lenders leveraging traditional, positive equity opportunities and, interestingly, the proliferation of new non-mortgage lenders offering unique home equity lending solutions. For instance, Home Equity Investments (HEI), which allows homeowners to tap a portion of their home equity in exchange for a share of its future value. This expanded supply of home equity lenders—and home equity lending products— opened the aperture to a broader range of borrowers who traditionally might not have qualified. That was good news for homeowners and their improved properties. But with the increased lending activity, however, comes increased risk of default. As lenders manage aging home equity portfolios and respond to continued market demand for new home equity lending, there’s a hidden risk indicator that is easily identified and affordably managed: property tax payments.

Non-traditional and specialty home equity lenders frequently don’t have insight into property tax risk and how to manage it, nor do they have the in-house resources to do so. They’re not set up to have escrow teams and don’t understand the many vagaries and nuances of property taxes: for instance, that different agencies and collectors (among the more than 24,000) have different payment methods or that taxes aren’t paid only once a year in states where there are quarterly or semi-annual payments.

Here are five scenarios in which it makes sense for home equity lenders to partner with a property tax expert in order to mitigate risk.

1. In many cases, home equity lenders are not the primary mortgage holder and, therefore, don’t have transparency into the first lien or payment history on the property. For these new origination home equity loans, a simple and affordable property tax certification will greatly mitigate the risk.
2. For non-escrow equity loan portfolios, proactive monitoring that delivers comprehensive tax status reporting and annual delinquency information is very affordable. This approach identifies when and where there is a problem so that steps can be taken to remedy those loans that are in trouble. LERETA provides customized delinquent letter services for non-escrow homeowners for this purpose.
3. Many nontraditional lenders that have an aged portfolio or a new portfolio as a result of an acquisition find value in more flexible delinquency solutions such as the LERETA Automated Delinquency Search. The flexible delinquency model is ideal for high-risk properties since it allows for checking delinquency status only on those properties that may show material risk factors, providing efficiencies and economies of scale without having to monitor an entire portfolio. This is particularly useful when the equity lender doesn’t have insight into the first lien. It uses a waterfall approach to identify risk factors such as low FICO scores and other property and loan characteristics, as well as the lender’s individual risk tolerance, to ascertain whether a property is delinquent or likely to go delinquent.
4. Beyond simply identifying which properties are delinquent, it’s important to determine whether or not the lender wants or needs to take action on a particular loan in order to meet their liability standards. Many real estate data services provide delinquency information, but are not equipped to help lenders understand what is probably at risk versus what is actually at risk, and, based on their criteria, how the risk should be addressed. Stale or incomplete data, or data that isn’t integrated with individual lender preferences, won’t be of much use in managing risk. In cases where the lender is the first lien holder, LERETA can provide a certified amount that gives the lender the option to make the payment if they so choose.
5. In some cases, a full redemption report—what LERETA calls a Tax Status Report—might be the appropriate solution in order to secure a complete history of tax payments, current status and any upcoming tax sales within a portfolio. This is particularly helpful with acquired equity portfolios in order to identify any surprises that may be lurking in the pool of loans.

There’s an interesting trend that shows more equity portfolios are moving to default teams, rather than being managed alongside the traditional servicing portfolio, whether or not the loans are in default. This uptick in taking a risk management approach to equity portfolios suggests lenders are seeing—and expect to see more—delinquent payments and/or defaults. When monitoring and managing property taxes is so cost effective at mitigating risk, not to mention the financial savings that can be realized by outsourcing this specialized service, isn’t it worth spending a little to save a lot?