Why a Home Equity Line of Credit Can Be Dangerous
A home equity line of credit can help during times when you need to bridge a financial gap. If you have the means to repay the loan, this could be a good tool for financing expenses such as a home renovation. However, some homeowners find themselves in a tight spot when their HELOC resets and they discover they can no longer afford the new monthly payments.
RealtyTrac’s HELOC Resetting Report reveals that roughly 3.3 million HELOCs taken out during the housing bubble between 2005 and 2008 will reset between 2015 and 2018. Approximately 56% of the HELOCs in this group are significantly underwater. The combined loan-to-value ratio of all outstanding loans is 125% or higher. The report goes on to say that 66% of HELOC resets are in California and the average monthly payment increase for this state over the next four years is $215.
If your HELOC is about to reset, or it already has, and you’re experiencing financial strain, there are steps you can take that might offer some relief. Bankrate’s senior vice president and chief financial analyst, Greg McBride, CFA, shared some helpful tips with The Cheat Sheet about what you can do if your HELOC reset is causing hardship.
The Cheat Sheet: What should consumers do if they can’t afford payments after the HELOC resets?
Greg McBride: There a few steps you can take. Right now, with mortgage rates near a two-year low, it’s a good opportunity to refinance your mortgage, anyway. And you can look to roll the home equity line into your mortgage refinancing.
There are a couple of other action steps that people can take. If this isn’t possible, another option is to refinance the home equity line itself. That will restart the clock on that 10-year draw period, but keep in mind that eventually you’re going to have to pay that balance back. And if you’re in a position where you have very limited equity, you’re underwater, or you’re out of work and you can’t qualify for any refinance, contact your lender and see if they can extend the repayment period to minimize the payment increase. In the long run it’s going to cost you more because you’ll be paying it over a longer period of time. But the benefit is that the payment shock won’t be as severe.
CS: Why are HELOC resets so problematic now?
GM: What makes this problematic now is the fact that these resets we’re going to see this year and the next couple of years are on home equity lines that were taken during the go-go days of the housing boom when credit was really cheap and equity was easy to come by. So there was a greater tendency for people to spend that money and rack up a big balance; and that balance is now going to have to be repaid. We haven’t been in an environment for the past 10 years where people are making a whole lot of headway paying that balance down. So that’s why it’s more of a problem now because there are so many people that took out home equity loans, and probably took it out for the wrong reasons and haven’t made any progress on paying it back.
CS: Which consumers are not ideal candidates for a HELOC?
GM: If you don’t have a demonstrated track record of being able to save money, then the last thing you need to be doing is borrow more, particularly if you’re using your home as collateral. You have to be disciplined about borrowing against the equity in your home, because otherwise you could get yourself into trouble. You can rack up a big balance and that really limits your overall financial flexibility and also puts you in a bind at the time when you may need the credit or when it comes time to pay it back.
CS: Which consumers might benefit from a HELOC?
GM: There are a lot of savvy individuals who look at a home equity line as a cheap source of capital. Interest rates are low, interest is often tax deductible, and that’s a much cheaper source of funds than liquidating other investments.