Hell’s coming for HELOC borrowers

helochell

Check your home equity line of credit’s “draw period.”

It may be about to end and when it does, your payment could hit the roof and end your homeownership.

In the “Drag Me To Hell,” movie (photo above) the loan officer gets it. In real life, you’ll be the victim.

Over the next few years, from 2014 to 2017, 58 percent of existing home equity lines of credit (HELOCs) – a type of second mortgage – will reach the end of their draw periods, according to the “Semi Annual Risk Perspective Spring 2012″ by the U.S. Department of the Treasury’s Office of the Comptroller of the Currency (OCC).

When that happens, you may not be able to afford the new cost of your HELOC.

A HELOC is an adjustable rate mortgage (ARM), a type of second mortgage that’s a lot like a credit card.

Unlike a home equity loan, which gives you a lump-sum, a fixed rate mortgage (FRM), and fixed payments for the term of the loan, a HELOC comes with a revolving line of credit, up to a certain limit.

With a HELOC, you only make payments on the portion of the credit line that you actually use and typically, you only have to pay the interest each month — until the end of the draw period.

The draw period is the period during which you can make withdrawals from your credit limit, typically 10 years, but sometimes longer. At the end of the draw period, withdrawals end and the HELOC becomes fully amortized, typically for 30 years, including the draw period.

For example, if your draw period was for 10 years and the HELOC is amortized for 30 years, you’ve got 20 years to pay off the loan when the draw period ends.

Limited luck of the draw

End-of-draw-period options vary from HELOC to HELOC, but each option poses a risk for those who aren’t prepared.

• Payment shock. After the draw period ends, you’ll have to make full monthly payments, both the interest and principal, for the duration of the amortization period.

Homeowners who’ve been comfortable with interest-only payments for much of the draw will get pinched by the added principal. Those who’ve barely been able to maintain interest-only payments could lose their homes.

• Interest rate shock. Interest rates have been at record lows on all mortgages, but during the remainder of a HELOC’s long amortization period of up to two decades, rates likely will rise again further increasing the cost of the full interest and principal payments.

• Balloon shock. Some HELOCs came with a balloon payment – the outstanding balance is due at the end the draw. Few can afford a payment of tens of thousands of dollars, or more.

Balloon’s and other HELOC’s often came with the pitch to refinance at the end of the draw, but that was nearly a decade ago when home values were skyrocketing.

Home equity losses have left an estimated one in three homeowners with underwater mortgages – mortgages larger than the home is worth.

Home values are improving, but may not come back fast enough to see you through your HELOC’s end of draw period.

In any event, tack on a second mortgage and many homeowners will long remain too deep underwater to refinance their way out of trouble.

Unless the existing first mortgage and the refinanced HELOC, combined, are sufficiently below the value of the home, risk-adverse lenders aren’t likely to grant a new loan.

If you know the end of your HELOC’s draw period is looming and a higher mortgage payment will threaten your homeownership, it’s time to get help now.

U.S. Department of Housing and Urban Development (HUD)-certified counseling is a good place to start.

About the author

DeadlineNews.Com's Publisher, Executive Editor and Founder, Broderick Perkins, was the first real estate journalist to manage a daily newspaper's online real estate section. He parlayed more than 30 years of old-school journalism into a digital real estate news service offering "News that really hits home!" -- the Silicon Valley bootstrap, DeadlineNews.Com. Network with Broderick Perkins on LinkedIn, FaceBook, Twitter, Google+ and the Bloomberg Business Exchange.

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