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What To Do About Your Aging Second Mortgage

A home equity line of credit (HELOC) provides much-needed cash for home projects, and other financial goals.

These loans are the cheapest and easiest way to tap into unused home equity. They can even cover a portion of your downpayment, via the 80/10/10 piggyback mortgage.

But they come with risks, too.

Repayment terms can be wildly unpredictable. Many HELOCs are about to “reset” after their 10-year interest-only period. Soon, the full principal and interest repayment will be required. This conversion is commonly known as a HELOC recast.

In some cases, HELOC payments could double.

To make matters worse, many lines of credit come with variable interest rates that are based on the federal funds rate. The rate can change as often as every six weeks, depending on Federal Reserve action.

So, you have a couple options to minimize the risk of sky-high payments. Learn these strategies, and start making steps to make your HELOC more affordable, no matter what happens.

Verify your new rate (Jan 18th, 2018)

The “Draw Period” Defined

HELOC loan terms are divided into two parts. During the “draw period,” you can tap the account as often as you wish and for as much as you like, up to your credit limit.

Your monthly payment varies based on the current prime rate, which itself is based on the federal funds rate. Fortunately, the Fed has kept rates stable for most of the last decade, and rate increases, if any, should be modest.

But most HELOCs work the same, despite the current rate environment. Your HELOC payment likely covers only the interest due on the current balance.

In five, ten or 15 years, depending on the loan, the draw period ends. At that point, you can no longer take money from your HELOC.

The repayment period commences, and here’s where borrowers can get tripped up. The troublesome element is the remaining loan term.

Verify your new rate (Jan 18th, 2018)

Know Your Repayment Term

Many HELOC customers don’t remember how long they have to repay their loan.

Draw periods often last 10 years. At that point, it’s hard to remember what the original loan paperwork said, and exactly what you signed up for.

For instance, some HELOCs come with a total 30-year term: a ten-year draw, and twenty-year repayment. Others require repayment in as little as five years following the draw period.

A 15-year HELOC with a $20,000 limit at five percent interest will require a payment of $160 per month. However, if you have a ten-year draw period, that means your repayment period is just five years. A payoff of that length will require $380 per month.

That’s not the only concern, however. Keep in mind that the rate is still variable. If the interest rate rises, the payment goes up even more.

What To Do Before Your HELOC Resets

If you’re in the early stages of your HELOC, now’s the time to consider an exit strategy.

The below chart shows how the repayment period length and the interest rate affect the monthly cost of a $20,000 HELOC.

 Repayment Term   4.00%   6.00%   8.00% 
 20 Years  $120  $140   $170
 10 Years  $200  $220   $240
 5 Years  $370  $390   $400

Now is the time to take action and get your balance down to an affordable range — before you’re obligated to a higher payment than you can make. The table below shoes how reducing your balance before the repayment period begins can keep your payment affordable.

 Balance   4.00%   6.00%   8.00% 
 $20,000  $370  $390   $405
 $15,000  $275  $300   $305
 $10,000  $185  $195   $200

Coming up with cash isn’t a solution for everyone, however. You might have to take other action to prevent your HELOC payment from rising beyond your reasonable ability to pay. Consider solutions that apply to HELOCs after they’ve reset.

Verify your new rate (Jan 18th, 2018)

What To Do After HELOC Repayment Period Begins

If your draw period is nearly at an end, or you can’t afford to start throwing bigger payments at your HELOC balance, you still have options.

Consider refinancing your HELOC into a fixed-rate second mortgage. You can’t draw any more on a fixed second mortgage; the balance will only go down as you make your monthly payment.  And, the fixed rate makes budgeting much easier.

Another option is combining your first mortgage and HELOC into one new loan. This can reduce your total monthly payment significantly. Understand, though, that extending repayment increases your total interest paid.

A cash-out refinance is available to applicants who are wrapping a first and second mortgage into one loan. Even though you are not getting cash-in-hand, many lenders consider paying off a HELOC a cash-out transaction.

Some programs consider paying off a second mortgage a “rate-and-term” refinance, however. These come with lower rates.

Lenders may consider a HELOC consolidation refinance a “no-cash” loan if the second mortgage was used to buy the home, or if you have not taken any draws in the past 12 months.

If refinancing isn’t an option, contact your lender about modifying your HELOC. The Home Affordable Modification Program (HAMP) has been extended to the end of 2016, so you’ll need to move fast to get a modification before the door closes. Check out the HUD-approved resource, HELOCHelp, for assistance with applicable government programs.

There are also private modifications offered by lenders. For example, some approve conversions to installment loans with fixed payments. You are more likely to receive this assistance if your mortgage balances exceed your home’s value, making foreclosure less attractive to your lender.

HELOCs can be fantastic sources of inexpensive, flexible financing. Before getting into one, however, create your exit strategy.

What Are Today’s Rates?

Mortgage rates are near 3-year lows, and many homeowners are combining their first and second mortgages into one low-rate loan.

Get a quote for a HELOC consolidation loan. No social security number is required to start, and all quotes come with access to your live mortgage credit scores.

Show Me Today’s Rates (Jan 18th, 2018)