HELs are loans backed by a residential property lien. An HEL is commonly used to finance the purchase of goods other than the home itself.
An HEL may be amortizing (also called “closed-end”) or non-amortizing (also called “open-end”). The closed-ended home equity loans are primarily used as collateral in asset-backed securities. The closed-ended HEL works just like an amortizing mortgage; it has a fixed maturity and equated payments that amortize the loan by its maturity date. HELs can be fixed-rate or floating-rate.
HEL Prepayments: While HELs have prepayment risk, it is very specific to the loans in the asset pool and their respective borrowers. The prospectus for an HEL collateralized ABS will contain a prospectus prepayment curve (PPC) which serves a similar purpose as the PSA for mortgage pass-throughs. While the PSA is a general benchmark, the PPC will be specific to the ABS.
HEL Payment Structure: Available Funds Cap
- ABS secured by HELs may be issued to investors with floating interest rates, but the underlying assets may have fixed rates.
- Available Funds Cap is stipulation employed by an ABS issuer to prevent a situation where interest paid on the ABS to investors does not exceed interest earned by the collateral in the asset pool.
In HEL ABS, the tranches are structured so as to provide some senior tranches more prepayment protection that other senior tranches. This is done through two structures: Non-Accelerating Senior (NAS) Tranche, and Planned Amortization Class (PAC) Tranche.
HEL ABS Non-Accelerating Senior (NAS) Tranche
- The NAS tranche gives greater prepayment protection than that provided to subordinate tranches.
- The NAS tranche will get principal payments based on a schedule that is a percentage of the tranche’s pro rata share.
- The NAS tranche will have more stable average lives in the early years of an ABS bond.
HEL ABS Planned Amortization Class (PAC) Tranche
- Like the NAS tranche, the PAC tranche is another method of offering prepayment protection to specific ABS investors.
- Support tranches will receive principal prepayments in line with the parameters of the PAC collar.