“Your HELOC is resetting” is a phrase you might be hearing a lot these days, and it sounds like something that might send your spaceship off its trajectory. But, if you’re not careful, it’s actually something that could send your budget off course.
The financial field is experiencing a perfect storm as multitudes of a popular financial product, the home equity line of credit, or HELOC, are coming due.
Why now? Well, homeowners rushed to take out HELOCs in 2007—just before the housing crash, when property values were at a peak. That gave homeowners flexibility to tap into much-needed funds during the rocky economic period of the past decade. But many of those HELOCs “reset” after 10 years, and with rising interest rates (just last week, the Fed announced another crucial rate hike), the mortgage math doesn’t look good. Your monthly payments could go higher—some by substantial amounts.
Let’s take a look at how you can deal with a resetting HELOC without busting your budget.
Why has my HELOC bill ballooned?
If you’re reading this, you probably already know what a HELOC is. But if it’s been 10 years since you reviewed your paperwork, here’s a refresher: A HELOC is a loan that allows you to borrow money against the equity you have built up in your home. Your lender figures out how much your house is currently worth, deducts what you still owe and offers you a percentage of the remainder as a loan.
What many borrowers don’t understand very well is that unlike their primary mortgage—whose interest rate is likely locked in for 20 or 30 years—a HELOC has a variable rate after the first 10 years. That variable rate is typically tied to the prime rate, which serves as a benchmark for lending rates. The prime rate increases when the Federal Reserve raises short-term rates.
HELOCs typically require interest-only payments for the first 10 years, after which payments on the principal kick in. So there’s a double whammy for homeowners who took out a HELOC in 2007: Not only are their principal payments coming due, but the rate on the loan is also poised to spike.
Now, we’re not trying to cause a panic; despite predictions that mortgage rates would rise throughout the year, they’re still historically low. The average rate for a 30-year fixed mortgage (the most popular home loan) is currently hovering at a seven-month low, despite several increases to interest rates since December. The Fed just hiked interest rates again, though, so the mortgage market could see some of that long-anticipated fallout.
How to handle a HELOC reset
This situation doesn’t have to be a disaster. You just have to do your homework to make the decision that’s best for your budget.
First—and most important—make sure you’re reading the correspondence from your lender and monitoring your statements each month so you’re not caught by surprise, warns Elizabeth Mitacchione, vice president of mortgages for Teachers Federal Credit Union, in Hauppauge, NY.
Evaluating your options could take some time, so you want to be clear on how and when the rate will change.
If your HELOC is poised to reset, you essentially have three choices: Pay it off, refinance it, or stay in your HELOC.
Option No. 1: Pay it off
Maybe you’ve been quite conservative when using your HELOC. It could be that you’ve just been spending a small amount of extra cash to spruce up your outdoor area or fix that leaky roof. Now that the project is done, you might well have the cash available to pay off your HELOC in one fell swoop. Done.
Option No. 2: Refinance it
Sorry, refinancing a HELOC isn’t cut-and-dried. You have three choices for how to handle it.
- Refinance into another HELOC: It’s a good time to look into this option, as many local banks and credit unions are currently very competitive with their rates, says Jesse Johnston of Philadelphia-based HOW Properties. HELOCs offer a variety of benefits, including the absence of closing costs and mortgage insurance, notes Joe Talmadge, vice president of mortgage lending for Northwest Federal Credit Union in Herndon, VA. However, he adds, “over time, the risk of having a large balance on a variable-rate loan with little protection from potentially rising rates could lead to more uncertainty than many people are comfortable with.” Also keep in mind that a new, comparable HELOC might not be possible if your home’s value has dropped over the past decade.
- Refinance it into a second mortgage: Many banks will allow you to convert your HELOC to a fixed-rate second mortgage without going through the process of requalifying for the loan all over again, Johnston says.
- Consolidate your first mortgage and HELOC into one: You may decide to do a full refinance of your first mortgage and HELOC while mortgage rates continue to be relatively low, Mitacchione suggests. Of course, that means you would need to pay closing costs, as well as go through the hassle of getting all your financial documentation together, notes Johnston.
Option No. 3: Stay in your HELOC
If you stay in your current HELOC, just remember that payment amounts will rise when the loan resets because you are no longer paying only interest. Your lender can walk you through the payment increase if you decide to just hold tight.