Why Your Home Equity Line of Credit Could Be a Ticking Time Bomb
NEW YORK ( MainStreet) Remember that home equity line of credit (HELOC) you took out a few years ago ? There may be an unpleasant surprise lurking in the not too distant future. Those interest-only payments you've been making may suddenly require interest and principal payments or worse yet, the loan may be maturing, requiring you to pay off the entire balance or scramble to refinance.
Nearly half of all HELOCs with balances at the end of 2013 were originated between 2005 and 2007, according to credit information company TransUnion. Many of those were issued with ten-year maturities or similar draw periods. At the end of a draw period, consumers can no longer borrow from the line of credit and must begin repaying the outstanding balance with fully amortized payments. If the HELOC matures at the end of ten years, the full balance is due.
"Home equity lines of credit were quite popular during the housing boom in the mid-2000s," said Steve Chaouki, head of financial services at TransUnion. "For many people, HELOCs represented a low-interest rate opportunity to borrow against the value of their homes, which were rapidly appreciating at the time. HELOCs generally had lower interest rates than credit cards or other loan types, and that interest was often tax-deductible."
As of the end of 2013, nearly 16 million U.S. consumers held about $474 billion in balances on HELOCs. More than half (52%) had balances exceeding $100,000.
"The financial shock associated with a HELOC payment increasing to cover both principal and interest can cause liquidity issues for some borrowers; this dynamic is driving significant concern in the lending marketplace," said Chaouki. "Our study indicates that up to $79 billion of those HELOC balances could be at elevated risk of default in the next few years."
Consumers with sufficient equity in their homes may be able to refinance the line of credit -- or sell their home to cover the debt. But in parts of the nation home values are struggling to recover to their pre-recession highs, and that, combined with rising mortgage interest rates, could mean some Americans may find themselves in HELOC hell.
The study offers an example of the "payment shock" consumers could face:
If a consumer took out an $80,000 10-year draw HELOC with a 7% interest rate in the mid-2000s, the monthly payment would equal $467 for the first ten years. At the end of the draw period, the payment would jump to $719 per month, as both principal and interest payments are required.
"For HELOC customers, we hope this serves as a reminder that higher payments may soon be on the horizon," added Chaouki. "Consumers should ensure they are aware of their financial circumstances and, if they are in this type of a situation, prepare for those larger payment responsibilities."