HELOC Pain: The Next Crisis?


The home equity line of credit, or HELOC, is a popular product for tapping into one’s home equity. But low monthly payments during the first few years can lull borrowers into a false sense of financial security. Large numbers of homeowners will soon be faced with the burden of repaying increasingly expensive HELOCs. This could lead to widespread problems.

SEE ALSO: Comparing Your Options: Cash-Out Refi vs. HELOC

Trouble Ahead For HELOC Borrowers

HELOC convenience and flexibility is enhanced by the fact that lenders require only interest payments during the first five or 10 years. This, of course, makes a HELOC exceptionally affordable. But, eventually, the principal that you borrow must be paid back, and the payments will go up. This is about to happen to many homeowners who tapped into their home equity, because it was an easy way to get cash during the first few years of this century. But it may trigger a major financial crisis. Although the housing market is gaining traction, many experts anticipate a severe wave of HELOC troubles within the next few years. This has the potential to trigger a calamity for both lenders and borrowers. Plus, it’s happening at a time when the economy is hoping that the housing market will provide healthy, optimistic performance.

The Perfect Storm

HELOCs are divided into two parts. The first is the “draw period,” and lasts five to 10 years. During this stage, the borrower can withdraw money from the line of credit, and is only required to make interest payments. After the draw period expires, however, the loan goes into the payback phase, where the borrower can no longer take out money. This can last for 10 to 20 years, during which time, the borrower must make payments of both interest and principal. A new report from the Office of the Comptroller of the Currency explains that nearly 60 percent of all HELOC borrowers will have to start making these higher payments within the next two to five years. To make matters worse, if prevailing rates rise as expected, borrowers with a variable rate HELOC will see theirinterest rates go up—just as they’re also forced to pay down their principal.

SEE ALSO: 5 Disadvantages Of Home Equity Loans

Few Alternatives Or Escape Routes

A common tactic for avoiding the higher payments is to refinance the HELOC before the payments accelerate. Then the borrower starts fresh with a new HELOC, and another interest-only introductory period. But the report predicts that an inability to refinance away from those increasingly expensive loans will likely complicate the situation. If the borrow can’t get a new HELOC, he can try to do a mortgage refinance and roll the HELOC amount into a new mortgage. But in today’s lending environment, it can be exceedingly difficult to get approved for a refinance. That makes it impossible to implement this kind of preemptive strategy. Relying on a refinance can be risky, because it’s not a sure bet and, without that kind of successful exit solution, the homeowner can face an unexpected repayment burden. A better plan is to not borrow heavily against your home equity, and to make optional payments of principal from the beginning, in order to pay off your HELOC as quickly as possible. That way, a HELOC is there when needed—for emergencies only—and it won’t create a financial emergency of its own.
Date of original publication:
Updated on: November 10, 2015

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