Is cash out refinancing on your agenda? Probably not, but if you're one of the nearly 8 million homeowners who signed up for home equity lines of credit (HELOCs) between 2005 and 2007, you might soon be forced to add it to your to-do list.
Looming HELOC Hell
On Aug. 7, TransUnion, one of the Big Three credit bureaus, issued a stark warning about the sustainability of many of the HELOCs dating from that period, and called the looming crisis a potential second housing bubble that could directly affect well over a million Americans, and put at elevated risk up to $79 billion of borrowing. So what's the problem?
Well, roughly half the 16 million current HELOCs, worth $438 billion, were originated during that three-year, 2005-07 period. And the most typical of these gave homeowners a 10-year term during which they could draw down on their lines of credit, meaning many millions of consumers are facing their "end-of-draw" (EOD) date over the next few years. During the initial decade, they could, if they chose (and many did), pay only interest on the amount they borrowed, and they could withdraw from their HELOCs to cover that if they chose. However, that EOD date brings a double whammy: Not only can they no longer draw down to pay their interest, but they also have to start paying down their principal balance. These post-EOD payments are also known as "fully amortized monthly payments."
TransUnion gives an example of what this could mean. Suppose a homeowner took out an $80,000 HELOC in 2005 at 7.00 percent APR. She'd have had to pay $467 a month between 2005 and 2015 to cover the interest, but could have used her line of credit to do that. Come her EOD next year, she can no longer tap the credit line and her monthly payments are set to rise to $719.
TransUnion calls this "payment shock," but identified another problem: "the vast majority" of those with HELOCs also carry other debt, so EODs could put credit cards, auto loans and other forms of borrowing at extra risk. As many as 20 percent of all those with HELOCs -- which translates into 3.2 million homeowners overall, and 1.6 million in the next few years -- could be at elevated risk of default, according to the credit bureau.
Home Equity Facts
If you're worried you might be among those one in five, you need to take the potential problem seriously. A key feature of all home equity products -- the thing that makes them such a cheap form of borrowing -- is that they are secured by your home. Fail to keep up payments, and there's a real chance you could face foreclosure.
On July 1, 2014, five federal agencies jointly published guidance for lenders over managing non-performing EODs. It suggested various remedies, including extending draw periods, modifying notes and revisiting amortization terms. However, it urged banks first to "conduct a thorough evaluation of the borrower's willingness and ability to repay the loan." And not all lenders are willing to contemplate the full range of relief. Some might take the opportunity to push borrowers into signing up for new products that might add to the overall cost of the loan.
Cash Out Refinancing the Best Option?
Those HELOCs with EODs due over the next three years or so were taken out during a time when almost everyone -- experts and homeowners alike -- thought the housing boom would go on and on. Only a tiny number of Cassandras forecast the bubble bursting. So it was in no way dumb back then for someone to sign up for a HELOC believing that, come EOD day, they'd be able to eliminate their debt by cash-out refinancing. Indeed, many still can. If you're lucky enough to live in one of the 13 states in which home prices reached, according to CoreLogic, record levels in June, then there's a good chance you can take that route. The same applies if you started out with a hefty enough amount of equity (the difference between the current market value of your property and the total amount of debt secured on it) in your home.
The question for you is: when should you refinance? Would it be better to do so now, or to wait until closer to your EOD date? Of course, nobody can guarantee their predictions of what's going to happen to mortgage rates (or how easily available home loans might be in the future), but most experts expect them to rise. For example, Fannie Mae's economics team currently forecasts that the 30-year fixed-rate mortgage rate is going to be at 4.7 percent during the last quarter of 2015, while the Mortgage Bankers Association's is forecasting 5.1 percent. If you still have faith in economists (and nobody could blame you if you didn't), you might want to begin to check refinance rates now.
What Else Can You Do?
Unfortunately, many HELOC holders won't be in a position to refinance. The equity in their homes will be too low to do so. Indeed, they may have negative equity, meaning their home loans are "underwater." What can you do if you're in that position?
The answers to that question are going to depend on your personal circumstances, but here are four ideas:
- Counterintuitively, one move that might be smart could be to draw down even more on your HELOC -- assuming you're not already hard up against your limit. If you're
- Another good move (and prepare to groan) could be to draw up a household budget and monitor your spending. This may be mind-numbingly boring, but it can identify wasteful expenditure and instill self-discipline, and has saved millions of consumers from the misery of unmanageable debt. The LendingTree Foundation provides online advice and free downloadable budget worksheets that can get you started.
- See whether you might be eligible for help under the federal Home Affordable Modification Program and the Second Lien Modification Program (2MP).
- Be sure to work with your lender, getting in touch before your EOD. HELOC providers are expecting a flood of worried borrowers to get in touch, so there's no need to be embarrassed when you call, and many provide dedicated experts whose role is to actively help you. The sooner you make contact, the easier things are likely to be.
HELOC hell may be looming for some, but there could well be things you can do to make sure you stay out of Hades.