Homeowners with home equity lines of credit (HELOC) have yet to feel the full benefits of the housing recovery and it could still be a while yet before they do.
The revolving credit style home equity loan was one of only two (along with mobile home loans) consumer loans to suffer rising delinquencies in the first quarter, according to the American Bankers Association (ABA) and matters could get worse.
ABA said the share of delinquent HELOCs rose from 1.85 of all HELOCs to 1.91 percent in the first quarter this year, compared to home equity loan delinquencies, which fell from 4.03 percent to 3.72 percent.
HELOCs are considered open-ended loans, much like credit cards, with revolving lines of credit, adjustable interest rates and fluctuating payments. Home equity loans are closed-end loans with a (usually) fixed rate, fixed term and fixed payments. Both are second mortgages, secured by the equity in the borrower's home.
ABA also included credit cards, auto loans, personal loans and other non-first mortgage consumer loans in its analysis and overall, consumer loan delinquencies were down 29 basis points from 1.99 percent to 1.70 percent in the first quarter. Home improvement loans were also down from 0.83 percent to 0.74 percent.
"Positive trends in home-related delinquencies reflect a stronger economy and rebounding home prices. Household net worth rebounded in the first quarter...rising home and stock prices create a wealth effect that boosts consumer confidence, which contributes to healthier finances and a greater ability to pay down debt," said James Chessen, ABA's chief economist.
So what's the problem with HELOCs?
Along with the other benefits of revolving credit, HELOCs come with an interest-only payment option, but only until the end of a draw period - the period of 10 years or so during which borrowers can make withdrawals up to their credit limit.
At the end of the draw, the jig is up - withdrawals end and the HELOC becomes fully amortized -- for example borrowers might get 20 years to repay a HELOC with a 10-year draw period.
Between 2014 and 2017, 58 percent of existing HELOCs will reach the end of their draw periods, according to the “Semi Annual Risk Perspective Spring 2012″ by the U.S. Department of the Treasury’s Office of the Comptroller of the Currency (OCC).
At that point the interest-only payment option vanishes and payments must include interest and principal. Terms vary, but full amortization can mean substantially larger payments, especially for those who've been paying interest only during the draw period. They could encounter several hazards:
- Payment Shock
"An increasing number of home equity lines of credit have gone from interest only to fully amortizing. This results in a payment shock for some borrowers who must adjust to paying down the principal, along with the interest," ABA's Chessen said.
- Interest Rate Shock
The higher payment stems not only from the combined interest and principal payment, but also, likely, a higher interest rate. Interest rates have been at or near record lows for nearly two years and are now on the rise. Also, lenders may compensate their risk for carrying the HELOC by raising rates and lowering loan limits.
- Balloon Shock
With some HELOCs the outstanding balance is due at the end of a draw, resulting in a balloon payment many can't afford. Homeowners who don't have enough equity to refinance could be out of luck.
There are some programs to help homeowners troubled by second mortgages, including HELOCs. However, unless there is a lot of home equity to work with, risk-adverse lenders might not grant a new loan.
The ABA says borrowers having trouble paying HELOCs or other debts shouldn't stick their heads in the sand and should take action promptly. Here are their recommendations:
- Sit down and talk with lenders. The sooner you seek help, the more options you have.
- Stop withdrawing money and charging purchases you can afford. Solve your financial problems.
- Consider putting the spouse to work or getting a second part-time job.
- Avoid bankruptcy. It's a short-term solution with long-term consequences.
- Contact a credit counselor from the U.S. Department of Housing and Urban Development (HUD), the National Foundation For Credit Counseling (Consumer Credit Counseling Service) or other HUD certified agencies.
If you have a HELOC and you're concerned about its interest rate increasing, consider converting it to a fixed rate home equity loan (some HELOCs have provisions that allow this) or refinancing it to a fixed rate home equity loan.