Ten years ago when you took out a home equity line of credit (HELOC), you assumed that when it was time to repay the principal, you’d be in a different financial situation. After all, you took out the HELOC to either consolidate debt, renovate your outdated kitchen or help pay for your child’s education or wedding.
And while you managed the monthly payment during the draw period — the first few years when you borrow as you like and pay only the interest — you suddenly feel overwhelmed by the new payments during the amortization period when you pay off the interest and the principal.
A HELOC has two stages: a draw period and a repayment period. The timeline can vary based on your institution and loan terms, but it most commonly follows a 10/15 term. This means there is a 10 year draw period (monthly payments are interest only) followed by a 15 year repayment or amortization period (monthly payment go up to cover principal and interest).
If you think you won’t be able to manage the payment increase, or if you have some additional projects you’d like to fund, you can refinance your HELOC. Even if the new interest rate is higher than your original loan, this might be the best option for you depending on your current financial situation. It’s important to crunch the numbers so you can determine which option is best suited for your circumstances.
HELOC payments can really jump
“Many people were unaware of how drastically their payment is going to go up,” says Peter Grabel, managing director with Luxury Mortgage in Stamford, Connecticut. “They’ve been making a nice, low payment of interest only, for 10 years at a very low rate.”
Your monthly payments rise sharply when the amortization period begins on a home equity line of credit. These payment amounts assume a 5.56% interest rate (the average HELOC interest rate at time of publication), a 10 year draw period and a 15-year repayment period. Payments would be greater with a higher interest rate or a shorter repayment period. It is important to check current HELOC rates before applying to ensure it makes sense to you financially.
|Amount owed||Interest only during draw period||Interest plus principal during amortization period|
Lenders remind borrowers
Banks encourage customers to deal proactively with the risk of a surging HELOC payment. According to Cynthia Balser, senior vice president and group manager of consumer credit products at KeyBank, “Somewhere between 6 to 12 months before the end of the draw period, banks are beginning to reach out, reminding clients that a decision they made 10 or 15 years ago is about to come due and asking the client to reach out if they have any concerns or questions.”
If you know your HELOC will enter the repayment period soon, and want to estimate what your new payments will be, use our HELOC Payoff Calculator and then evaluate your budget.
4 ways to refinance a HELOC
If you think you may not be able to cover the amortization period payments, there are a few ways to refinance your HELOC.
- Talk to your lender. Some banks offer home equity assistance programs and will adjust your interest rate, loan period or monthly payments if you don’t think you will be able to afford the payments or have suffered some sort of financial hardship. TD Bank and Bank of America, for example, have such programs.
- Get a new HELOC. While this may be delaying the inevitable, starting a new draw period may make the most sense for you. Be aware, however, that interest rates may rise, meaning you could pay even more money in the long run. This option may make the most sense if you are young and have years to build more equity and make more money.
- Get a home equity loan. A home equity loan differs from a line of credit because you get the money in one lump sum. A fixed amount, a fixed interest rate, and potentially a longer repayment period, may make this an affordable option for you.
- Refinance your HELOC and mortgage into a new mortgage. Consider refinancing into a 15- or 20-year mortgage to reduce total interest payments. While interest rates on primary mortgages are favorable, you have to take into account closing costs when you take this approach. It’s best if you keep the house long enough for the cumulative monthly savings to outweigh the costs of refinancing.
Weigh all the costs
Home equity loans have much lower closing costs than primary mortgages. The disadvantage is that interest rates on equity loans are typically higher than on primary mortgages.
If you refinance into another HELOC, be aware of heightened underwriting standards. A decade ago, you could qualify on the basis of the interest-only payments. Today, you have to prove that you can afford the fully amortizing payments.
And if this is your first mortgage application since 2008, you might be surprised by how much documentation you now have to provide.
Another thing to consider is the new tax law and how it impacts HELOCs. While you used to be able to deduct interest on your HELOC up to $100,000, now you can only deduct funds that are used to “buy, build or substantially improve the taxpayer’s home that secures the loan,” according to the Internal Revenue Service.
Finally, check for hidden fees, know both your credit score and how much equity you have, and educate yourself on current loan terms and rates.
Underwater homes are an exception
If you have ended up in a situation where you owe more than your home is worth, contact your lender.
“If the value is not there now, it’s going to be difficult to qualify for a new loan,” says Rick Huard, senior vice president of consumer lending product management at TD Bank. “That’s one of the situations where you definitely need to contact your bank, talk to your loan officer and see what options you have available. They can take a look at your financial picture and be able to work things out with you.”
Still in the draw period?
If you can swing it, apply some money each month toward the principal. As is the case with throwing a few extra bucks toward your monthly mortgage — or making an extra payment each year — even small amounts can make a difference in the long run.