During the housing boom of the mid 2000s many people took out home equity lines of credit (HELOCs) for greater financial flexibility, to have as a safety net, or as a means to avoid property mortgage insurance (PMI) by enabling them to make a 20% down payment on a home purchase.
And why not? Interest rates were very low and the process for getting approved was fairly easy for many consumers.
Many of the HELOCs opened at this time featured an interest-only period of 5,7 or 10 years followed by either a balloon payment at maturity or an amortization period requiring monthly payments of principal and interest.
What this means “in plain English” is potential payment shock as your monthly HELOC payment may spike drastically, up to 30% or more in some cases.
You are not alone as a lot of consumers may be affected by this pending HELOC reset situation. The Office of the Comptroller of the Currency estimates that 60% of all HELOC balances ($167 billion) will start amortizing between 2014 and 2017.
What can you do?
- Review your HELOC terms to understand exactly what will happen to your monthly payment when your HELOC “recasts” (when your HELOC converts from interest-only payments to principal-plus-interest payments). Contact your lender directly if you need help understanding the terms of your HELOC, as the loan documentation can be difficult to interpret.
- Interact with your lender to determine if you are able to refinance your HELOC, and to figure out if refinancing makes sense for you. The banks are aware of this pending “recast” phenomenon and you may want to contact them to discuss options.
- If you decide to refinance, be sure to clean up your credit so you can qualify for a more favorable interest rate. That means pay down revolving balances as far as possible, ensure you are current on all your bills, and don’t open new credit accounts. The FICO Score usually factors quite predominantly in the credit evaluation process, so visit myFICO.com for access to your FICO Score and information on how to manage your score.
- If your monthly HELOC payments are likely to increase, then take time to prepare a monthly household budget so you don’t suffer “sticker shock” when the higher HELOC payments kick in.
- As more consumers begin to be impacted by HELOC resets, the government may create programs to assist borrowers who are unable to refinance their loans and are experiencing financial hardships – such as the second-lien modification program, known as 2MP, created by Treasury in 2009. Ask your lender if they have information about any such programs.
Tom Quinn is the Vice President of Business Development for myFICO® , and has over 20 years of experience working with consumers, regulators and lenders and regarding credit related questions and initiatives.