HELOC Payment Shock Coming?

HELOC Payment Shock Coming?
HELOC Payment Shock Coming?

So, what’s a HELOC and why are things changing with them?  Well, a HELOC is a Home Equity Line of Credit.  This is an equity line, with an adjustable rate.  Usually, only interest payments are required during the first 10 years of the note.  After that, they reset to include principal payments sufficient to retire all the debt in the remaining years of the note.  The new payment can be as much as 30% higher.

A recent National Mortgage News article (http://www.nationalmortgagenews.com/dailybriefing/payment-shock-on-helocs-a-looming-concern-for-regional-banks-1040806-1.html) highlighted the pressures on banks and borrowers posed by the resetting of HELOC’s originated before the financial/real estate crisis.

For retirees on fixed incomes, increased mortgage payments could present significant problems.  Beyond the question of property values, borrowers may not find it as easy to refinance as they did a decade ago when they were still working full time.  Faced with increased payments, some could find themselves drawing down their retirement investments faster than anticipated.

Often when people take out a traditional or forward HELOC, the prospect of its coming due in 20 or 30 years doesn’t feel like a problem.  After all, in the meantime there are just the interest payments and rates have been low for a long time now.

One of the most difficult parts of maintaining a credible retirement income strategy is sustainability in the face of diminishing investment returns and personal health. Money is only going in one direction during the distribution phase, but everything else can go up or down.

The resetting of $325 billion in Home Equity Lines of Credit over the next 3 years could place pressures on a lot of homeowners and banks; they will be looking for solutions.  “Bank of America also disclosed that 63% of home equity borrowers did not pay any principal on their HELOCs,” the Mortgage National News article reported,  “Meanwhile, Wells Fargo has disclosed that 45% of its HELOC borrowers paid only the minimum amount due.  Roughly 2.5% of Wells’ HELOCs were delinquent at the end of the third quarter.”

Yes, the payments and setup costs are very low and attractive with the HELOC.  As a short-term loan it is hard to beat.  But as part of a long-term strategy during our retirement years, its limitations and risks can prove unacceptable.  Most HELOC’s can be closed or called by the lender if home values go down or the borrower encounters credit problems.  They come due and the payments can escalate.

For homeowner’s 62 and over there is the option of a Deferred Payment HELOC or Home Equity Conversion Mortgage (HECM) reverse mortgage.  It is still a Home Equity Line of Credit, but payments are optional .  as long as the owner maintains the property as his/her primary residence and keeps up the property taxes and home insurance, the loan doesn’t come due until the last borrower dies or moves.

Because the federal government through the Federal Housing Administration (FHA) insures HECM’s, they cannot be called or canceled even if home values decline, the bank goes out of business, or the borrower develops credit problems.  Even more remarkably, the credit line actually increases over time independent of the property value.  It also protects the borrower and heirs from owing more than the property will sell for.

Yes, HECM’s are more expensive to set up than traditional HELOC’s.  However, most of that cost is directly related to protecting the homeowner from risks like escalating payments caused by the resetting of thousands of regular HELOC’s over the next several years.

HELOC forward or reverse, each has its advantages and disadvantages.  Before you do either, shouldn’t you at least understand both?  You can learn more about HECM’s at https://vermontfunk.com.  It’s a site designed to answer questions without requiring your personal information.

Parting Thought:  “When we are no longer able to change a situation. we are challenged to change ourselves.”  Viktor E Frankl

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About the author

Scott Funk has specialized in Home Equity Conversion Mortgage reverse mortgages for over a decade. He is a recognized Aging in Place advocate in his home state of Vermont. His monthly newspaper column Aging in Place has run for 7 years in 24 papers around the state. Scott is brings a lighthearted approach to his talks on Boomers, retirement and aging on purpose.