Paying more now could save your home later
The traditional home equity line of credit — an initially cheap but financially risky loan that allows borrowers to make interest-only payments for years — is all but dead at the nation's leading mortgage lender.
Wells Fargo now requires most borrowers to pay both interest and a portion of their loan balance each month, which means minimum payments will increase for many homeowners.
But the increase could be as little as $20 or $30 a month, depending on the size of your loan.
This change should put to rest (at least for Wells' customers) the payment shock HELOC borrowers may experience when their interest-only period ends and their monthly payments double or even triple. Indeed, paying more now could save your home later.
With a traditional 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. This is the period in which borrowers are required to repay only the interest.
But when the draw period ends, homeowners can no longer borrow against the line of credit and must start repaying whatever balance remains — perhaps over the next 10 to 20 years.
The move by Wells Fargo means HELOCs opened with this bank will now amortize over 30 years, like a traditional mortgage.
"We believe that the amortizing payment option is in the best interest of our customers," says Kelly Kockos, a senior vice president and home equity product manager at Wells. "It helps them pay down debt by reducing principal and interest, allows for affordable payments that reflect a true pay-down schedule and helps mitigate the risk of payment shock at the end-of-draw period."
This change comes as 817,000 homeowners who opened home equity lines in 2004 will have to begin repaying principal this year, according to the credit bureau Equifax.
Not surprisingly, the Wall Street Journal reports delinquency rates have doubled on lines opened during the housing bubble that have reached the end of their interest-only period.
This shows the trouble borrowers have coping with suddenly increased minimum monthly payments. And it could spell financial disaster for some of these borrowers because they could lose their homes to foreclosure.
So far, Wells Fargo is the only major lender to demand some principal repayment right away, but two of its biggest competitors — JPMorgan Chase and Bank of America — are at least thinking about it.
Typical monthly payments for most Wells customers will rise. How much depends on the credit line balance, the years remaining on the loan and the interest rate, which is variable.
For example, the interest-only monthly payment on a $30,000 HELOC at 4.875% APR would be about $121 (assuming you borrowed your limit when you opened the line). A fully amortizing payment including principal initially would be $159.
Wells customers with at least $1 million in savings or other liquid assets still have the option of making interest-only payments for the first 10 years.
"It makes eminent sense to start requiring at least some principal payments on HELOCs," says Stuart Feldstein, president of SMR Research Corp. in Hackettstown, N.J., which studies the industry. "It makes sense for the bank, and it makes sense for the borrower. Although no one likes to pay more each month than they once did, the net result will be that homeowners will build equity in housing faster and therefore increase their net worth."
Feldstein says even with increased monthly payments, HELOCs remain the cheapest consumer loan available — a far better alternative than high-interest credit cards.
But Wells Fargo will face competition from thousands of smaller banks and credit unions that still offer interest-only lines of credit.
For example, the country's largest credit union — Navy Federal Credit Union — has no plans to change or eliminate its interest-only options, says Richard Morris, vice president of equity lending. Morris says only a "small percentage" of the CU's members choose interest-only loans.