Ten years ago – back when real estate values were beginning to soar and mortgages were as easy to get as dinner reservations – a lot of people took out home equity lines of credit (HELOCs). Now the good times are over and the HELOCs which once seemed so alluring are coming due. That's a problem; in fact, some people believe that exploding HELOCs may lead to a massive new round of foreclosures.
What Is a HELOC?
Let's start with some basics:
In general terms, a HELOC is like a giant credit card (a revolving line of credit that you can access as you please). It allows property owners to access the equity in their homes without selling or refinancing their first mortgage. The HELOC is a mortgage, however, and is secured by a lien against your house and subject to foreclosure if you default.
HELOCs were easy to get between 2000 and 2006; lenders often offered such financing with no closing costs as long as the borrower took out a minimum amount to start, say $25,000. Once the HELOC was in place, borrowers then paid interest on the outstanding balance. If they also paid back some or all of the loan balance, then the line of credit increased, just like a credit card. No doubt some borrowers paid no closing costs, got a $25,000 check at closing, and then put back some or all of the money the next month, thus creating a huge line of credit for emergencies at no cost.
How a HELOC Is Repaid
HELOCs were a quick and easy way to finance a business or send a child to college. Compared to credit cards, HELOCs were a lot cheaper, the lines of credit could be much larger and the interest was generally deductible. But – like all loans – there comes that magic moment when financing needs to be repaid.
HELOCs differed and so repayment requirements also differed. For instance, consider one standard product – a HELOC with a 10-year term and no closing costs. At the end of 10 years, all advances and interest had to be fully repaid, just like any 10-year mortgage. In other words, it could be a balloon note with a huge final payment if borrowers weren't careful.
Other HELOCs had a "draw period," say five or 10 years, a time when money could be taken out. Once the draw period ended, the loan entered the repayment phase, which was when the homeowner was responsible for repaying the loan. The entire loan term could last 15, 20 or even 25 years.
Many HELOCs had a minimum monthly repayment requirement which varied according to the outstanding balance and current mortgage rates – some HELOCs had fixed rates, but many were ARMs which means payments could rise or fall along with rates. As long as you paid the monthly minimum you were good with the lender – at least until now when large numbers of HELOCs are coming to a close.
What to Do If Your HELOC Is About to Expire
What can you do if you have a maturing HELOC? Here are the basic steps to take:
First, speak with your loan servicer. Make sure you understand when the loan term ends and how much is currently owed.
Second, if repayment is a problem, ask the servicer to extend the HELOC term. Lenders are no more interested in a foreclosure than you are, and some will reboot the loan for you (fees may apply).
Third, check your finances. Can you simply pay off the balance? Remember that an unpaid HELOC can not only lead to foreclosure, in some cases it can also mean a huge tax bill since the Mortgage Forgiveness Debt Relief Act of 2007 expired at the end of 2013. That means Uncle Sam may tax unpaid mortgage debt as if it was income.
Fourth, refinance – you might do better with a fixed second mortgage with unchanging payments, which makes budgeting easier and forces you to repay the balance without running it back up. Or, you can replace your expiring HELOC with a new one. Finally, look into refinancing your first mortgage and wrapping the HELOC into the new loan. If you have enough equity (mortgage insurance kicks in if your loan-to-value exceeds 80 percent) and can improve on the terms of your first mortgage, this may be your best solution.
What If You Lack Equity Needed?
But what if your home is worth less than it was; what if you lack equity? While millions of homes have added equity in the past few years, RealtyTrac reports that in December there were 9.3 million homes that remained deeply underwater, an expression which means that the mortgage balance was at least 25 percent higher than the property's fair market value. If you have negative equity or not enough equity for a regular refinance, then ask lenders if you qualify for federal help with such programs as HAMP, HARP or the Second Lien Modification Program (2MP).
Lastly, if you have a HELOC coming due, don't hesitate to speak with lenders and explore all available options. Exploding HELOCs won't go away; they'll just create havoc if not resolved.