A decade ago, when home values were soaring and real estate was booming, many homeowners took advantage by taking cash out from the equity in their home. Typically, the loan was structured as a Home Equity Line of Credit (aka “HELOC”), which functions very much like a typical consumer credit card. Specifically, a homeowner will pay minimum payments on only the portion that is being borrowed, and would not necessarily be obligated to pay any loan-principal back. Furthermore, the rates on these HELOC’s were extremely favorable, often with very low teaser rates, and the payment was low due to the interest-only features.
The Freebies
In fact, many banks ‘threw in’ a free HELOC to customers who didn’t need, or didn’t ask for them. More often than not, if someone applied for a first mortgage, whether it was to purchase or refinance their home, the bank pre-approved them for a no obligation line of credit without any additional cost or fees. Their hope was that if you give the consumer the ‘access’ to these lines of credits, one day in a pinch, or when in need-of, they would easily draw on these credit lines and the bank would have another loan on their books. The best part to the bank was that they actually had real estate as collateral which was more favorable to them than any type of consumer-direct loan that they could offer.
The Mechanics
Most HELOC’s have a 10-year draw period during which borrowers may use the money as needed, paying back all or none of the principal on a monthly basis. At the end of the 10-year draw period, the line of credit is no longer accessible, and the outstanding balance then converts to the repayment term, where both principal and interest fixed installment payments are made, typically over a 10 or 20-year period.
The Trouble
According to a report by RealtyTrac, which compiles housing data, they estimate that about 3.3 million home equity credit lines totaling approximately $158 billion were still open, and were scheduled to reset between 2015 and 2018. More than half of those loans are on homes that were seriously “underwater” – which means the borrower owed more in total debt than the home is worth. These payments, when reset, could increase a borrower’s monthly payment by $550-$750 a month for loan balances near $100,000.
The Fed
The “Prime Rate”, which most HELOC’s are tied, is currently 3.5%. The Federal Reserve has already made one rate increase, and there is talk of at least 2 to 4 increases during 2016. When the Fed’s raise rates, it has a direct impact on the Prime Rate. What most people fail to realize and remember is that despite the record low prime rates, over the past 30 years prime has been as high as 22%, and has averaged 11% over this time period. What goes down must come up, and we might be on the brink of that happening shortly.
The Solution
Even if one can afford the increase in HELOC payments, it does not mean there aren’t financial or tax benefits to consider. There are many options for people who have HELOC’s that are in repayment, or about to be in repayment. With careful analysis of your full situation I can guide you with the most beneficial and financially responsible loan option that you can get.
By Shmuel Shayowitz
Shmuel Shayowitz (NMLS#19871) is President and Chief Lending Officer at Approved Funding, a privately held local mortgage banker and direct lender. Approved Funding is a mortgage company offering competitive interest rates as well specialty niche programs on all types of Residential and Commercial properties. Shmuel has over 20 years of industry experience including licenses and certifications as certified mortgage underwriter, residential review appraiser, licensed real estate agent, and direct FHA specialized underwriter. He can be reached via email at [email protected].
