Refinancing a HELOC Could Rescue Your Budget
Did you take out a home equity line of credit 10 years ago? If so, you're not alone. These loan products, better known as HELOCs, were popular in 2006 and 2007 as home values soared and homeowners looked to tap into their growing equity.
Unfortunately for borrowers, many of these HELOCs are now set to move into a second stage. And as they do? Their monthly payments are set to jump, often by hundreds of dollars.
This can cause a sudden financial jolt for homeowners.
Fortunately, there is a solution: You can refinance your HELOC, either to a new line of credit or by combining it with the balance of your primary mortgage. This isn’t always easy, though, and not all owners will qualify for one.
Some owners might have to accept the higher monthly payments, take out a second mortgage loan -- a home equity loan -- to pay off the HELOC or dip into their savings to pay off their now more costly HELOC.
How HELOCS work
Homeowners often confuse HELOCs with home equity loans. Both are types of second mortgages. But there is a big difference.
A standard home equity loan is pretty straightforward. . You can borrow an amount of money based on how much equity is in your home. If you have $50,000 worth of equity, you might be able to borrow $30,000.
You’d receive this money in one lump sum and then pay it back each month – with interest – in installment payments, just as you do with your primary mortgage.
HELOCs are different, acting more like a credit card. You again can borrow a certain amount of money based on the equity of your home. Say you qualify for a line of credit of $30,000. You then borrow $20,000 to pay for a major kitchen remodel. If you then pay back $10,000 toward the principal balance of that loan, you are left with $20,000 in available credit.
The challenge
Jeremy Colonna, loan officer with Matchpoint Funding in Los Angeles, said many homeowners with HELOCs might be facing some financial pain. Many HELOCs were originated in 2006 and 2007 as interest-only vehicles, meaning that borrowers have only been paying the interest on them and not paying down the principal balances of these lines of credit.
When the interest-only period of these products ends -- which is happening now for a large number of homeowners -- the HELOCs evolve into more traditional mortgages. This means that homeowners who were only paying interest, will now have to start paying interest and principal.
"Depending on interest rate, these homeowners are experiencing payment increases of 50 percent to 90 percent," Colonna said. "Obviously, this can absolutely blow apart a family budget."
Two phases
HELOCs come with two stages. The first stage is the most affordable. This is known as the draw period, and during it, homeowners only pay off the interest on their loans.
During this first phase -- it usually lasts 10 years, but can vary -- payments are lower. This makes sense, as owners are only paying off interest.
But when the draw period ends, HELOCs enter their second phase, the amortization period. During this stage, owners have to pay principal and interest. If you still owe a significant amount of money on your HELOC, your monthly payment can jump significantly during this period, often by hundreds of dollars.
Time to refinance?
The obvious solution is for homeowners to refinance these HELOCs into more affordable loans with lower interest rates to help lessen the financial blow.
Homeowners can refinance their HELOCs into a new home equity line of credit, one starting over with a new draw period and the lower monthly payments that come with it. Or they can refinance both their HELOC and the balance of their principal mortgage into a single home loan. This will eliminate the HELOC, and leave homeowners with just one – more affordable – monthly payment.
Others might choose to apply for a regular home equity loan, and then use the lump-sum payment to pay off the HELOC. This will leave owners with a second mortgage payment to make each month. But the hope is that this payment will be a lower one than the payment associated with the HELOC.
Problem is, many of these now-transitioning HELOCs were closed during the real estate boom, when home values were especially high. Homeowners whose residences were worth $300,000 in 2006, might now be paying off a home that is worth only $200,000. This means that they might not have enough, or any, equity in their homes to even close a refinance, Colonna said. Most lenders require at least some equity for a refinance.
Then there are changing guidelines. Many homeowners might discover that refinancing regulations, including on HELOCs, are tougher today. Colonna said that homeowners who might have qualified for that home equity loan in 2005 might no longer qualify for a refinance today.
As if all this wasn't aggravating enough, refinancing a home equity loan or HELOC requires plenty of paperwork today, Colonna said. In fact, lenders will want just as much documentation -- everything from bank statements and tax returns to W-2s and pay stubs -- as they'd request from owners trying to refinance a primary mortgage.
"Much of the documentation may seem unnecessary and redundant," Colonna said. "It is absolutely necessary. Believe me, loan originators and processors get just as frustrated requesting the documentation as borrowers get being asked."
If you can’t refinance? You might have to use your savings to pay off that HELOC if you don’t want the higher monthly savings. If you don’t have enough savings, you might have to simply accept your higher HELOC payments.
And if you can’t afford these payments and can’t refinance? Call your lender immediately. Your lender might be able to work out a compromise – such as deferring monthly payments for a time or lowering your interest rate – as you work out a financial solution.
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