Everyone knows the Boy Scout motto “Be Prepared”. That’s good advice when it comes to your mortgage, too. During the next few years, $352 billion in adjustable rate home equity lines of credit will transition from the draw period (that time when the line of credit functions like a credit card) to the repayment period (that time when the line functions just like a typical closed end mortgage). The draw period and the repayment time period varies between lenders but typically the draw is 10 years and the repayment is 15 years in duration. It’s important to be aware of how this transition will affect your personal finances.
This transition to the repayment period is very important because it means that your HELOC payment will almost certainly increase. During the draw period, homeowners typically only pay the interest due on the outstanding debt. The interest rate on HELOCs is almost always an adjustable rate based upon the Prime Rate (as published in the Wall Street Journal) or the LIBOR index (London Inter-Bank Offer Rate). LIBOR is a lot like the Discount Rate here in the U.S. because it is the rate that banks charge each other for loans. These “indexes” can be found at www.mortgage-x.com or www.fedprimerate.com. Some lenders will allow the borrower to convert their HELOC to a fixed interest rate that is typically a few percent higher than the current rate for first mortgage loans.
Citibank alone has over $14 billion HELOCs that will transition into the repayment period between now and 2017, so they have a genuine interest in how this process unfolds. Citibank management estimates that the typical monthly payment could increase by an average of about $400 per month. They estimate that the typical HELOC payment will increase by 170 percent so it makes sense to plan for this increase. You could contact a reputable, knowledgeable mortgage lender to discuss converting the outstanding balance to a fixed rate or you could consider refinancing your first mortgage to pay off the HELOC and convert to a lower fixed interest rate.
That 170 percent increase that Citi estimated seemed high so I did some calculations based upon figures more representative of our market here in Lake Tahoe and the Carson Valley. Using historical interest rate cycles and government projections from the CBO as a guide, it’s reasonable to expect rates to rise by the summer of 2015 and likely double (at least) by their estimated peak in 2024. A $100K HELOC priced at Prime plus 1.0 percent results in an interest-only payment (during the draw period) of $354 / month. With no increase in interest rates the payment will increase to $752 per month when the loan converts to a fully-amortized 15 year mortgage during the repayment period. But with rates rising, your payment will also increase – a two percent increase in the Prime Rate (very likely in the next five to 10 years) will have a noteworthy impact on your HELOC payment. Even just a two percent increase in interest rates can add up to a big and potentially unnecessary expense over the 15 years repayment period.
It’s important to be aware of how your HELOC payment will increase when the line of credit converts to a regular mortgage during the repayment period. With interest rates still very low, your options are still attractive. But if you wait too long and interest rates increase, your options will be much less inviting. So remember that old Boy Scout motto and you just might save yourself significant money over the next fifteen years.
Mark Treiber is a senior mortgage originator with One Trust Home Loans, 297 Kingsbury Grade, Suite 207, Stateline.He can be reached at 775-671-3952.