A big payment shock is on the way for many homeowners who have borrowed money under home-equity lines of credit they signed up for prior to the housing bust.
Helocs allow borrowers to withdraw equity from their homes to spend on renovations and other expenses. There is often a 10-year period during which the borrower can tap the credit line and make minimum payments of interest only.
That 10-year period is soon coming to an end for millions of borrowers whose monthly payments are set to spike once required principal payments kick in. Already, delinquencies are rising as some borrowers have a difficult time keeping up, according to a story Monday in the Journal.
The good news is that borrowers who are nearing the end of their interest-only period and are current on their Helocs have several options to handle changes to their Heloc payments -- before they kick in. Here's what to consider, as well as some moves for borrowers who have fallen behind.
For homeowners who want additional borrowing power
With most Helocs, borrowers aren't able to increase their borrowing under the credit line after 10 years have elapsed from when they signed up. One way to regain that borrowing power is to try to sign up for a new Heloc that replaces the old one, says Keith Gumbinger, a vice president at HSH.com, a home-loan information website.
For example, a borrower who had a $100,000 line of credit and used $30,000 could roll over the $30,000 balance into a new $100,000 line of credit and have access to the remaining $70,000. The borrower would be able to tap into this equity over the next 10 years, in most cases, and depending on the lender could make interest-only payments. The borrower would likely also be able to defer principal payments on the old $30,000 balance for another 10 years.
Keep in mind that getting a new Heloc -- or one that is as large as your previous line -- may not be possible if your home's value dropped substantially during the downturn and hasn't fully recovered or if your mortgage and other loans secured by the house total nearly all of your home's value.
Borrowers should also consider the costs involved. Closing costs can run up to around $500 for a Heloc, says Mr. Gumbinger. But the interest rates on a new Heloc could be much higher than what they're currently paying.
For borrowers worried about rising interest rates
Heloc borrowers should play close attention to their interest rates.
Heloc interest rates are usually variable and most are pegged to the prime rate, which typically moves in tandem with short-term interest rates set by the Federal Reserve. When the Fed eventually raises rates, which might happen later this year, that will likely lead to increased Heloc rates, pushing borrowers' payments up further.
Borrowers can see if it's worth converting to a fixed rate. Some borrowers may prefer to have the peace of mind of an interest rate that doesn't change even if it is higher than what they currently are paying.
The average rate given out on home-equity loans, which generally have a fixed interest rate, was 6.2% as of May, says Mr. Gumbinger.
Meanwhile, many Helocs given out during the last housing boom are tied to the prime rate and don't have a margin, meaning that interest rates on those Helocs stand at 3.25%, he says. Some of these Helocs charge less than prime while others tack on an additional two percentage points or more, making those borrowers' rates at least 5.25%, currently. Borrowers should read their contract to determine what their margin is, which will help them determine whether switching to a fixed rate makes sense.
Another option is to find out whether the interest rate on your Heloc balance converts to a fixed rate after the interest-only period or if you can switch to a fixed rate, an arrangement that would be mentioned in your contract. While some banks offer this option, however, their interest rates could also be relatively high.
It may be worthwhile to stick with your variable rate -- especially if it's significantly lower than current rates on new loans -- if you believe that you can pay off your balance over the next couple of years. Should the Fed raise rates during that period, the increases could still leave you with a lower rate than what's available today.
The refinancing option
Borrowers who have a primary mortgage and a Heloc may want to consider if refinancing makes sense for them. By refinancing, they can roll their mortgage and Heloc into the new primary mortgage and end up with one monthly payment on their home.
This also serves to stretch out the repayment period if you are getting a new 30-year fixed-rate mortgage, and it removes the uncertainty of rising rates pushing up the cost of the Heloc. A refi is also another way to borrow more of your home equity.
Whether a refi makes sense for borrowers depends on several factors, including how much equity they have in their home. Lenders typically require borrowers involved in this type of transaction to have at least 25% equity in their home after they get the new mortgage, says Mr. Gumbinger.
Borrowers also need to consider when they last refinanced. Those who refinanced in 2012, when interest rates reached a bottom, might not want to get a new mortgage if it means ending up with a higher interest rate. Also, borrowers generally incur closing costs of around 2% of the new mortgage amount on refinances, says Mr. Gumbinger. If they refinanced recently, incurring those costs again might not make much sense.
If you're worried about falling behind
Regulators have been encouraging banks to work with borrowers who are at risk of falling behind on Heloc payments. Many banks have been contacting borrowers prior to their interest-only period ending to inform borrowers of their new payments and to find out whether they can afford them.
Borrowers who haven't heard from their lenders should contact them. They will need to walk them through their current income and expenses -- including their other debt obligations, such as their mortgage and car loan -- and be prepared to submit documentation proving those numbers.
Some banks will rework the terms of the Heloc by offering to extend the repayment period or defer interest payments in order to lower the monthly payments and make them more manageable. Borrowers who owe more on their home than it is worth may also find such options. Bank of America, for example, is offering such borrowers the option to extend the repayment period from 15 to 25 years to lower their monthly payments and keep them current on repayment. Citigroup says it works with such borrowers individually and may defer interest on a portion of the principal until the end of the payback period.
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