During the housing boom, Home Equity Lines of Credit (called HELOCs) became a favored way to tap home equity. Qualification requirements were minimal; closing costs were low; and, interest only monthly payments provided wide-spread appeal. However, a new report from TD Bank documents a number of emerging and disturbing facts about HELOCs that are especially important for senior homeowners.
The Repayment Period: Misconceptions Challenge Senior Homeowners Most
Most home equity lines of credit include two phases:
- Draw period: up to 10 years when funds can be drawn down and repaid as the borrower elects.
- Repayment period (called reset): the credit line is closed, and monthly payments are increased to include principal and interest payments to repay the balance by the maturity date.
According to the TD Bank report, 43% of U.S. homeowners will be enter into a HELOC reset over the next few years. Unfortunately, most of them are unaware or are not prepared for payment increases. The report revealed that:
- 33% were not aware of the reset provision in the agreement. That number increased to 42% among seniors.
- 34% believe their payments will be reduced when the HELOC resets. Only 19% understand their payments will increase.
- 60% do not have a plan for their HELOC resets, and indicated they do not plan to seek guidance from their lenders.
- 53% of HELOC borrowers opening accounts between 2005 and 2008 don’t know what the impact on their monthly payments will be at the time of reset (2015 – 2018).
Payment increase shock from home equity lines of credit resets affects senior homeowners most severely at a time when financial resources are most limited. Alarmingly, the majority of senior homeowners are unaware of this pending reality, and unprepared for the consequences of higher monthly payments, which may not be affordable.
Triple Threat from Payment Resets
Most home equity lines of credit are adjustable rate mortgages (ARMs), which means the interest rate and monthly payments are vulnerable to future rate changes. This creates a triple threat for homeowners who enter into a HELOC reset:
- Higher (reset) monthly payments may be subjected to ongoing increases if rates continue to rise.
- The record low interest rates of recent years have minimized payment requirements thus far. However, higher future interest rates combined with monthly payments that increase to include principal and interest to pay the balance off mean that the calculated increases could be sizable.
- HELOCs that are accompanied by a superior first mortgage present additional risk, especially if the first mortgage is an ARM and is also subject to payment increases if/when interest rates rise. The combined monthly payment increases could potentially cripple household budgets.
Home equity line of credit defaults and foreclosures have already begun, and more are expected in coming years. In the wake of the Great Recession (2008–2013) new lending industry and regulatory restrictions have increased eligibility requirements, which may prevent some seniors qualifying for traditional refinancing options.
What to Do Now – Investigate and Make a Plan
Home equity line of credit reset problems are real and foreseeable. You can take control and make a plan for managing the reset period by following these steps:
- Understand the timing and terms of your loan agreements
Begin by examining the terms of your HELOC agreement carefully. Understand when the draw period ends, and the reset terms of the repayment period.
- Consider your resources, circumstances and objectives
Determine what the impact will be on your payment obligations and financial resources.
- Make a plan to address future payment increases
While every homeowner’s plan to address a HELOC reset will differ based on their unique financial situation and loan agreement, the following strategies can help you consider several different options:
- Refinance to a traditional mortgage or HELOC (if qualified and affordable).
- Payoff balance with other resources if available and appropriate.
- Refinance to a reverse mortgage, which will eliminate future payments and not come due until the last senior homeowner permanently leaves the home.
- Sell home and relocate (downsize, rent, or move in with a family member).