Home Equity Lines of Credit (HELOC’s) became a very popular loan product ten years ago. Most tout the benefits, but don’t understand the potential huge pitfalls.........
Most HELOC’s are based on the following terms:
- 30-year loan period
- First 10 years allows for a credit line draw period (like credit cards)
- Draw period usually allows for an interest only payment
- Next 20 years has fully amortized (principal & interest) payment based on remaining 20-year term
- Interest rate is adjustable using prime rate + a fixed margin (established at onset of loan)
PITFALL #1
The payment can increase dramatically after the initial interest only draw period.
For example, if a homeowner borrows $100,000 on a HELOC at 3.5% (prime rate of 3.25% + .25% margin), the interest only payment would be $291/month. Even if rates don’t increase when the 20-year fully amortized period hits, the payment would go up to $580/month...double the current payment!
Now imagine a $200,000 HELOC with rates adjusting to 6.0% for the repayment period. The payment would go from $583 interest only, to $1,433...an $850/month increase!
PITFALL #2
A credit line can be frozen at any time, preventing future draws on the line. This means those who are using their line of credit as a safety net, aren’t really safe. There’s no substitute for savings!
HOW YOU CAN USE THIS:
Many HELOCs were acquired 10 years ago, meaning those draw periods are coming due. Those with HELOCs need to know the potential pitfalls. With rates once again near all-time lows and home values up, now might be the time to suggest consolidating lines of credit into a low, fixed-rate mortgage. It may help your clients protect against a huge payment increase.
Contact us with questions...we’re here to help!