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When HELOCs Collapse

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Posted On: 10/29/2014

Question: In 2006, just before the real estate market collapsed, we got a $100,000 home equity line of credit. The lender cut off our ability to borrow against the line a few years later – but not before we had taken out about $80,000. We’ve been making regular payments, but there has to come a point where the balance will be due, and we don’t have it. What can we do to avoid foreclosure?

Answer: In general terms a home equity line of credit – a HELOC – has two phases: a “draw” period and a “pay-down” or “payback” period. During the draw period you can take out money and often make only minimal monthly payments, say interest-only. In the pay-down period you can no longer make withdrawals; instead the lender looks at the balance and calculates a monthly payment that equals enough to pay back the debt and interest.

In your case – and you are not alone – what you have is an exploding HELOC. TransUnion estimates that HELOCs worth as much as $79 billion will end in the next few years and have an “elevated risk of default.” In rough terms, we’re talking about several million HELOCs.

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Like many HELOC borrowers you found that when home values went down the lender claimed the right to limit or end withdrawals. You now have a balance and can no longer take out money. The question is: How do you pay off the debt and avoid foreclosure?

You need to contact your lender for specifics, but let’s make some assumptions and say that your loan has a 10-year draw period and a 5-year pay-down period. You now have $80,000 outstanding, and on an interest-only basis at 6 percent you’re paying $400 a month to keep the loan current.

If you still owe $80,000 once the payback period begins and the interest rate is still 6 percent your monthly payment will jump to $1,547. Of course, if the interest rate is higher then the payment will be that much larger.

Here are some steps you can take:

First, begin now to pay $1,500 a month. This will lower your debt by the time the payback period starts and pay down some of the outstanding principal.

Second, adding $1,100 a month to your payment may be impossible, so you need to look for alternatives. If the value of your home has increased, if you have sufficient equity, you may be able to refinance at today’s rates, about 4 percent as of this writing.

Third, if the value of your house has declined then there will be insufficient equity to refinance the debt. You need to ask the lender if the debt can be modified, perhaps converted into a fixed-rate loan at today’s rates with a 30-year term. At 4 percent the monthly payment for a self-amortizing, 30-year loan will be $382.

Why would the lender agree to a modification? A HELOC usually is a second loan. If your property is foreclosed the sale of the house will be used to repay all secured debts – but not equally. The first loan must be completely repaid before any money is given to the second lien, the HELOC. The lender might be willing to modify the HELOC because the alternative is a foreclosure, and maybe no money for the second loan. While things look grim you actually have some leverage because things could be worse.

You might get modification help with the government’s Making Home Affordable program, specifically its Second Lien Modification Program. Because there are various conditions and restrictions you really want to look into this alternative now, today, before the payback period begins and while the program is still available.

Peter G. Miller is the author of The Common-Sense Mortgage and a veteran real estate columnist. Have a question? Please write to peter@ctwfeatures.com.

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