ADVICE: Home equity 101
By Molly Hensley-Clancy
NEW YORK — If you are one of the millions of Americans who took out a home equity line of credit (HELOC) in the midst of the housing bubble, there is a good chance you need to start paying it back soon, and at a higher interest rate.
In pre-crisis years, banks aggressively marketed HELOCs to consumers, allowing homeowners to obtain them with little income verification and limited appraisals. They promised easy cash for banks and borrowers alike, requiring feasible interest-only payments that are often tax-deductible.
But after 10 years, most HELOCs enter a repayment period, during which borrowers can no longer take money out of their credit line and must pay down the principal.
As reported by Reuters, more than $221 billion of these loans at the largest banks will hit their 10-year anniversary during the next four years. That amounts to about 40 percent of outstanding home equity lines of credit.
Here are five things to consider if you have a HELOC.
Figure out the finances
After the typical 10-year date, a borrower with a $30,000 HELOC at an interest rate of 3.25 percent would have to make payments of $293.16, according to analysts from Fitch Ratings.
The first step for consumers with HELOCs is to understand their loan’s terms, says Robert Mecca, a financial adviser.
Most loans have a 10-year open period during which borrowers pay only interest, followed by a 10-year repayment period. Some offer 15-year repayment periods, and some rare lines of credit must be paid back in full immediately.
But people often don’t realize the repayment period is coming up, says Mecca. “Some are even surprised that there’s a final maturity date at all.”
Pay down principal
The Federal Reserve has indicated that its benchmark interest rate could begin to rise as early as 2015, something that will filter through the banking system. As a result, borrowers’ payments could go up even more drastically.
“If you’re looking to ease the pain of adjustment, chipping away at the balance is the best way to do it. It’s more productive now, at the time of low interest rates, because more of each dollar goes towards the principal,” says Greg McBride, an analyst at Bankrate.com.
Experts warn, however, not to go too far. Given fluctuating home prices, dumping large chunks of your liquidity into your home is ill-advised.
“I wouldn’t suggest emptying your 401(k) to pay down your line of credit, no matter how high the balance,” says Keith Gumbinger, vice president at mortgage-advice site HSH.com. “A lot of folks have learned the hard way in 2008 that having equity in your home isn’t the same thing as having cash available.”
Peter Grabel, a loan originator with Luxury Mortgage in New York, advises some clients to lower their payments by combining a HELOC with a first mortgage. “You don’t have to worry about the rate changing, and you can pay back over 30 years if you want to,” Grabel says. “The downside is you’re adding a lot more time to your mortgage.”
Grabel worked with a couple who wondered what to do with a $200,000 HELOC set to hit its 10-year anniversary in 2015. The line’s outstanding balance was low, just around $10,000. The couple had 22 years and $300,000 left on a $370,000 mortgage -and they also wanted to buy their daughter, who had just graduated from college, a condo.
Rather than directly using their credit line, which had a variable rate, Grabel helped the couple roll the credit line into a new $535,000 mortgage. They bought the condo with cash, also managing to pay off $20,000 in credit card debt and significantly lowering their pre-crisis mortgage rate to 4.25 percent.
Pay down debt
Gumbinger suggests borrowers consider putting their last few years of an equity line of credit to good use — borrowing and repaying it like a credit card.
“Just remember that the more money you put on that line of credit, the more pain you have coming up,” McBride notes.
Borrowers with outstanding credit card debt should consider using their home equity lines of credit to consolidate, since interest rates on credit cards are far higher.
If you’re considering selling your house, it could be worth your while to borrow money for improvement projects, like kitchen and bathroom upgrades, that will increase your home’s value.
If your borrowing needs exceed your loan’s 10-year anniversary date, you can look into securing a new line of credit — but be aware that things have changed since the crisis. Banks now require much more thorough documentation of income and assets, and homes are subject to a full appraisal.
Borrowers who have seen their home values — and thus their equity — shrink substantially post-crash may no longer qualify.
“Conditions were probably a lot easier the first time you walked in the door,” Gumbinger says.