Dear Dr. Don,
I have a home equity line of credit, or HELOC, for $110,000 that expires in September 2016. I do not have a mortgage. I won't need to use the home equity line until 2015 when my children head to college. I'd like to help them avoid student loans and the debt this involves.
I feel like I can tap the HELOC since I don't have the expense of mortgage payments. Could you explain what happens upon expiration of the HELOC when I expect to have a balance?
Would it help if I lock in a rate now for the entire amount? I just know I can't afford a very high monthly payment.
-- Gerri Graduation
A typical HELOC has a time period when you can draw against the line of credit. During the draw period, the line only requires a monthly payment equal to interest expense. Once the draw period is over, the loan converts to an amortized loan. That's when the monthly payment covers interest expense and principal repayment over the remaining loan term. It's common for a HELOC to have a 10-year draw period followed by a 10- to 20-year period when it is an amortized loan. Since some HELOCs have balloon payments at the end of the draw period, be sure to review your loan documents. If there's any doubt about them, speak with your lender.
I can understand why you want your children to graduate without the burden of large loan balances. Still, I'd ask you to consider having them fill out a Free Application for Federal Student Aid, or FAFSA, and borrow up to the limit of the direct student loan program. As we like to say, it gives them some skin in the game. It helps a student to recognize that this is an investment in education for their future -- not just asking you to mortgage your own.
Check out the terms of your existing HELOC. If you took it out eight years ago, it could carry a rate below the prime rate, currently 3.25 percent. The Bankrate national average on a new HELOC is 4.87 percent. The terms of your existing HELOC will influence the timing and amount of the draw. Taking the money out a year before you need it and two years before the draw period expires doesn't make sense. Waiting until the end of the draw period also doesn't make sense.
If you borrow $110,000 on an amortized basis over 20 years, the monthly payment at an average interest rate of 4 percent is $666.58. A 10-year repayment period translates to monthly payments of $1,113.70. A HELOC has a variable interest rate. I made an estimate based on an average of 4 percent. Your payments would likely be different, of course.