Clock is ticking on all the lines of credit written during the housing bubble

Clock and dollar sign balanced on teeter-totter

Uh-oh.

All of those home equity lines of credit people took out during the housing bubble are coming due.

With a HELOC, borrowers get a line of credit against the equity in their home to use and repay as they like during what’s called the “draw period” – typically the first 10 years of the loan.

Over that time, borrowers are only required to pay the monthly interest on the outstanding balance.

But when the draw period ends, homeowners can no longer borrow against the line of credit and must start repaying whatever balance remains.

As Gretchen Morgenson points out in the Sunday New York Times, a lot of HELOCs were written between 2003 and 2008 when soaring property values provided homeowners will a lot of new equity to tap.

While those borrowers had the option to repay all or part of the principal each month, many didn’t, especially after the financial crisis hit in 2008.

That means the clock is ticking for all of those homeowners who took full advantage of their $15,000, $30,000 or more lines of credit.

When they have to start repaying the principal, their minimum monthly payments on these second mortgages are going to shoot up. And by shoot up, we mean they can triple.

That can be a major shock to homeowners who have only been paying the interest on a loan. They now have to pick up the principal and interest tab for multiple loan payments – their first mortgage and their HELOC.

Morgenson cites a new study by the Office of the Comptroller of the Currency that says the draw period will end for almost 60% of all HELOCs between 2014 and 2017.

This year, she says, the repayment period is beginning for $11 billion in home equity lines. By 2018, that number jumps to $111 billion.

The fact that borrowers will have to start repaying the principal isn’t the only problem they’ll face.

Most HELOCs have adjustable interest rates tied to the prime rate, which is currently at a record low.

If the Federal Reserve starts pushing interest rates higher in late 2013 or 2014, as it currently projects, then the interest charge on all of these loans will go up as well.

There’s no easy way out of this.

Since the bubble popped and home values have plummeted since 2008, most borrowers don’t have nearly enough equity to refinance their debt into a new HELOC or traditional home equity loan.

They’re going to have to find more money in their budget to repay these loans. If they don't, they'll default on their HELOCs and could face foreclosure.

How much will the payments increase?

Well, let’s say you owe $30,000 at 4% interest. The current interest-only minimum payment is about $100 a month.

When you have to start repaying that loan over a 10-year period (a fairly typical term for a HELOC) the minimum monthly payment rises to a little over $300.

That assumes the interest rate remains at 4%. If it adjusts upward to 6%, the payment increases to something like $330.

If you're holding one of these loans, you need to check when your draw period ends and how much your minimum payments will go up when it does.

The earlier you know, and the sooner you start paying down the principal, the better off you’ll be.