Helocs from hell
The cost of a home equity line of credit has soared over the past two years.
By Les Christie, CNNMoney.com staff writer
August 1 2006: 1:44 PM EDT
NEW YORK (CNNMoney.com ) -- During the past few years, millions of Americans fell in love with home equity lines of credit. These "helocs" are easy and inexpensive to obtain and they carried very low interest rates - until recently.
But what was a bargain two years ago can be a burden today. Consider: The monthly interest payment on a loan of, say, $50,000, has more than doubled in two years, to more than $333.
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Helocs are credits that can be drawn from and typically act as interest-only loans with terms of five to 25 years after which the principal must be repaid. Interest is tied to the prime, the rate banks charge their best customers, which has soared since June 2004, to 8.25 percent from just 4 percent.
The ease of obtaining a Heloc makes them very tempting. "It means mostly just walking down to the bank and asking for one," says Keith Gumbinger, vice president of vice president at HSH Associates, a publisher of consumer loan information.
They're not all bad. The interest on Helocs is deductible and they can be used to retire more expensive debt.
"If you're doing it to pay off expensive credit card debt, or for needed home improvement or to pay for education, there's nothing wrong with that. But many people are using it for day-to-day expenses. For them, the danger is they've been given a new tool - for digging themselves a deeper hole."
Used to buy homes
In some high-priced housing markets, according to Ted Gross, a director of the National Association of Mortgage Brokers, people used Helocs to afford pricey homes.
"A lot of people took out Helocs because it's the only way banks would allow them to purchase with less than 20 percent down," says Ellen Bitton, CEO of Park Avenue Mortgage Group.
She explains that some banks would extend a conventional mortgage loan for only 80 percent of the purchase price. Borrowers had to come up with the rest as cash downpayments. The bank would extend a Heloc, which was backed by the equity of the home, for all or a portion of that downpayment.
Other borrowers, says Bitton, used Helocs simply because the loans were so cheap. "Many people who bought property a few years ago thought, 'Rates are so low, I'll just [buy it with] a Heloc.' Now they're going to pay for it."
The loans, says Gross, left borrowers with highly leveraged and with even higher rates. For those with loan values (including mortgage and heloc) above 95 percent of the home value, the heloc rate would be prime plus 2 percent. That adds up to 10.25 percent currently.
A hypothetical $500,000 house bought a couple of years ago came with a mortgage of $400,000 and a Heloc of $75,000 with $25,000 cash down. The Heloc portion of the monthly payment came to just $375. Two years later, the Heloc portion of the loan repayment has risen by $250 a month. Those who just barely afforded the home at first could face real trouble trying to come up with the extra cash every month.
Home prices slow - Heloc use does not
Even though the cost of having a Heloc has soared, their popularity hasn't declined. According to the Federal Deposit Insurance Corporation (FDIC) whose member banks account for a great majority of the Helocs in effect in the United States, the dollar volume of these loans hit $531 billion in March, the last figure available, up 28 percent form $416 billion in June 2004.
According to David Barr, a spokesman for FDIC, homeowners had turned away from refinancing their primary mortgages recently because of higher interest rates. "But they keep turning to Helocs to extract cash from the equity in their homes," he says.
If the value of their house declines sharply, borrowers could wind up owing more than the house is worth. If they have to sell, they would have to pony up cash.
What to do
How can borrowers get out of a Heloc hole?
Prepay the loan. If they have the cash, they could pay off the loan immediately. If it's less than three years since taking out the loan, however, they would probably incur a penalty of between $350 and $500. That's probably worth it, especially for a large loan.
Take a cash-out refi. Refinance the primary mortgage and pay back the full amount of the Heloc. Rates are a couple of points lower on a 30-year fixed rate today than on a Heloc. Application fees, title search and insurance and other expenses will increase the total debt but monthly payments may still be lower than the blended total of the old primary mortgage and the Heloc. Plus, with a fixed rate, borrowers know exactly what their payments will be.
For borrowers with low rate primary mortgages, however, this is not recommended; they would be refinancing at a higher interest rate. Currently, 30-year fixed rate loan average 6.72 percent.
Switch to a fixed rate home equity loan. Unlike Helocs, home-equity loans are usually fixed-rate loans. They don't cost as much as a mortgage refinancing to execute but there still are some closing costs. Plus interest rates run a point or so higher than for 30-year, fixed rate mortgages, but that's still a savings compared with Helocs.
According to George Yacik, vice president of SMR Research, many banks are offering to slide Heloc customers into fixed-rate loan to keep their business.
* See the latest mortgage rates.
* Protect yourself against the higher rates of adjustable rate mortgages
* See the latest on home prices from around the USA.
. La situación actual es de bloqueo, como tambien apuntan por ahí: "si yo no compro tu no vendes" .
