Mortgages: Is It Time to Refinance Your Home Equity Line of Credit?

For many mortgage borrowers, home equity lines of credit – HELOCs – have been both good news and bad. The good news is that they provide quick and cheap access to real estate equity. The bad news is that, like all debts, they have to be repaid and for some borrowers that is now a problem.

To understand what's happening, take a look at HELOCs and how they work. A HELOC is a loan secured by a home. Borrowers can take out cash up to a credit limit. Borrowers can also put money back into the loan. When they add money, then more credit is available for future use. For instance, Smith has a $75,000 HELOC and borrows $10,000. There is now $65,000 in additional borrowing power remaining. If Smith repays $5,000, the available line of credit then goes up to $70,000.

HELOCs are organized into two phases. First there is a "draw" period which allows the borrower to both take money from the line of credit and put it back. Then there is a "repayment" phase during which time the borrower must repay the debt. With our 15-year loan, there might be a 10-year draw period and then five years for repayment.

For many borrowers, their HELOC has now entered the repayment period and that means required monthly payments. For instance, if Smith owes $50,000 at the end of 10 years and must now repay the debt over five years at 6 percent interest, the monthly payment for principal and interest will be $967.

Of course, 10 years ago – back in 2006 – real estate values were soaring and then came the financial meltdown. Now borrowers find that the debt acquired back then is entering the repayment period but the monthly payment is a budget buster. What can Smith and other borrowers do to repay the debt?

Happily, there's good news for borrowers.

First, home values have been rising. With more equity, borrowers can more readily refinance. According to more than 6 million homes which were "seriously underwater" in 2012 now have positive equity.

"Rising home prices are lifting all home equity boats: bailing out seriously underwater homeowners and enriching homeowners who already have positive equity," said Daren Blomquist, senior vice president at ATTOM Data Solutions, the new parent company of RealtyTrac. "Nationwide home prices reached a new all-time high in June on the heels of 52 consecutive months of annual increases. While that national trend is consistent in most markets across the country, there are still some local markets and sub-markets that have been largely left behind by the housing recovery and which still have a high percentage of underwater homeowners."

Second, interest rates have fallen. According to the Freddie Mac, the typical mortgage rate in 2006 was 6.41 percent versus 3.46 percent at the start of September. That's a drop of nearly 3 percent, a huge decline.

New Mortgages & HELOCs

Given these numbers, many borrowers with older HELOCs are in a position to solve the problem of soaring monthly payments. In basic terms there are two strategies:

First, combine the existing mortgage and HELOC and refinance into a single loan with a lower monthly payment. The payment should be lower because the new loan will have a 30-year term, thus stretching out the repayment period, plus today's interest rates are far lower than in 2006.

Second, replace the current HELOC with either a new HELOC or a second mortgage. In either case, the monthly payments should again fall.

For additional information, speak with lenders and ask what they would recommend given your equity and credit profile.

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