Prepare for the end of HELOC draw period

Dear Dr. Don,
I have a 3.25 percent adjustable home equity line of credit. The draw period on the HELOC ends next April when it will convert to an amortized 20-year home equity loan at the 3.25 percent adjustable rate. I’m considering maxing out the loan. Our finances are complicated. The last home loan application process was unpleasant, to say the least. I don’t want the hassle of applying for another HELOC. What are the pros and cons?

— Nancy N. Hock

Dear Nancy,
It is true: The game has changed regarding how financial institutions price HELOCs. Loans like yours were priced using the prime rate of interest. Banks got tired of lending consumers money at prime so they put in a floor that’s above that level. As I write this to you, the Bankrate national average interest rate for a HELOC is 4.81 percent.

Borrowers — many of our readers among them — with older HELOCs at better rates (like yourself) are getting nervous because of the pending end of draw periods. Most loans are structured with a 10-year draw period, like yours. At the end of this time frame, these loans have adjustable rates but are no longer interest-only. The monthly payments increase to cover interest expense and repayment of principal over the remaining loan-term, typically 20 years. Monthly loan payments increase substantially. Homeowners consider refinancing into 30-year fixed-rate mortgages to keep the payments more affordable.

You’re taking a different approach than most folks. As I understand, you want to max out your HELOC and accept the new amortized payment with its 20-year term. I’m guessing you have income or credit issues making it difficult to qualify for a new mortgage.

How are you going to use the money? Are you going to restructure debt to reduce your expected interest expense? Are you going to invest the funds or take a vacation? There are responsible reasons to max out the draw on the line of credit. Vacations and speculative investments are not wise options.

Can you handle the interest-rate risk? The Federal Reserve might raise rates in 2015, but we’re talking about 20 years remaining on the loan. How long you plan to stay in the house can have an impact, too. If you have enough equity in your home, the loans get paid off when you sell. With a three- to five-year horizon, you won’t be facing 20 years of potentially rising interest rates.

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