HELOC second mortgages are often structured with interest-only payments, but that convenience doesn't last forever.

Some things can be forgotten, and others can't. Forget the meal that made you sick, and the meeting that you botched at work. But don't forget that you have to pay off the outstanding principal on your second mortgage line of credit.

Low payment, more cash

HELOCs are convenient and powerful financial tools. You can use one to tap your home equity on demand, without having to pay interest on funds that you don't use immediately. You can access a large amount of cash quickly in exchange for a relatively small monthly repayment burden. The minimum monthly payment on a HELOC often covers only the accrued interest that, depending on the interest rate, can make the HELOC more affordable than an amortizing mortgage loan.

Surprise, your bill is due

An interest-only payment is easy on the cash flow, but it doesn't do anything to pay off the money that you've borrowed. In fact, you can make every HELOC payment as promised, and still find yourself in a hole after 10 years.

How could this happen? HELOCs usually have two phases-a draw period and a repayment period. Let's say that your HELOC has a 10-year draw period followed by a 10-year repayment cycle. On the 10th anniversary of your HELOC funding, the outstanding balance will convert into a fully amortizing loan. The payments will be large enough to ensure that the loan is paid down to zero at the final maturity date. As an example, a $50,000 balance that's restructured into a 6 percent, 10-year loan would require a monthly payment of about $555. This compares to a $250 interest-only payment at the same rate.

The details of your HELOC could be quite different, depending on what you owe, what rate you're paying now, how long the repayment period is, and what rate is applied to the amortizing payments.

Payoff is in the planning

A little planning can help you avoid an unpleasant HELOC surprise. Here's the step-by-step:

  1. Pull out your paperwork and read your debt terms. Locate the conversion date, the length of the repayment period, and how the repayment interest rate is determined.
  2. Use a mortgage payment calculator to discover what your payments will be if you don't reduce your HELOC balance at all before it converts.
  3. If it looks like your payment will be too high after the conversion, calculate the payments for various lower principal balances. When you get to a payment level you can afford, jot down the balance figure-that's your target.
  4. Now go to Mortgageloan.com's Line of Credit Payments Calculator and determine the extra monthly payment necessary to reduce your balance to the target before your HELOC converts.

No matter what, always remember the golden rule of borrowing: what you borrow, you must pay back.

Published on June 20, 2008