HELOCs are Making Lenders Nervous...Here's Why

Billions of dollars in home equity lines of credit (HELOCs) are coming due, and it’s creating anxiety in the marketplace.

According to a study by credit information provider TransUnion, the majority of HELOCs originated between 2005 and 2007 have balances of more than $100,000, and up to $79 billion of those balances could be at risk of default in the coming few years.

As of the end of 2013, TransUnion estimates $438 billion in HELCO will reach their end of draw period in the next few years. The impact of this will undoubtedly be felt by mortgage lenders, but it can also hurt credit card issuers and other debt providers if homeowners can’t make their payment.

“A lot of lenders are concerned that HELOCs coming to the end of draw period will cause a lot of pain and maybe even a second recession,” says Ezra Becker, co-author of the study and vice president of research and consulting for TransUnion. “But we have some good news: less than 20% are at elevated risks of going delinquent.”

With a HELOC, homeowners who borrow against their line of credit typically have a period of interest-only payments. When they hit their end of draw period, they start paying both the interest and principal on payments, which can increase the monthly amount by as much as 50%. They can no longer borrow from the line of credit at that point.

The increased payments might not be a problem for some borrowers, but for cash-strapped homeowners, they could have a harder time making the higher repayments and lead to higher a number of defaults.

Not surprising, the consumers who are at risk of default are those that have low credit scores and limited cash flow living paycheck to paycheck, according to TransUnion’s research. Those who are underwater on their loan or don’t have a good exit strategy could also have higher default rates.

The value of the home is also a predictor of who’s at risk of default, says Becker.

“If they can’t refinance or sell the house, it will be more difficult to manage the payment shock,” he says. “If you have positive equity, you have options.”

If you are one of the countless homeowners with a HELOC nearing its end of draw period, there are things you can do to prepare for the repayment.

Becker recommends first re-familiarizing yourself with the terms of the HELOC and when the end of draw period kicks in.

“Even if you have a low interest rate, the fact that the payments will not only include principal and interest can make it rise by 50%,” he says. “You need to start planning from a budgeting perspective.”

For some homeowners, the higher payments might mean eating out less or skipping a vacation, but knowing what the new payment will be in advanced puts you in a better position to account for it.

If you aren’t going to be able to make the repayment each month you have options. You can refinance, or if that’s not possible get in touch with your lender immediately and explain the situation.

Institutions are willing to work with clients to find alternatives to taking the property.  “A lot of lenders have policies and practices to account for proactive contact from consumers,” says Becker.