We talk a lot about credit card debt here at ReadyForZero but there are many types of credit that impact a consumer’s financial health. From student loans to mortgages, credit isn’t confined to a piece of plastic. Recently, one specific type of credit was given extra attention in the news: the Home Equity Line of Credit. The reason? For many borrowers, the draw period for these loans is coming to an end. But before we get into the details of what this means, let’s look at the basics.
What is a HELOC?
For those of you unfamiliar with the term Home Equity Line of Credit (or HELOC), it works like this:
When you take out a HELOC you agree to put up your house as collateral in exchange for the loan. Essentially, this means that should you fail to make payments to the lender, they can take your home. Once a HELOC is taken on, a borrower can then draw from the line of credit during what’s called a “draw period.” This period typically lasts 10 years but once elapsed, the borrower is required to begin making payments on their principal balance in addition to interest payments. HELOCs (as are any other loans) are serious financial agreements and carry particular heft since the consequences of default involve the loss of a borrower’s home.
The Danger At Hand
HELOCs have a “draw period,” which is essentially an agreed upon timeline during which borrowers can continue drawing credit from their loan while making interest only payments. For the many HELOCs taken out in the early 2000s, that 10 year “draw period” is rapidly coming to a close. This means that those who took on HELOCs after 2004 are facing the upcoming reality of required repayment on the principal of their loan.
For those who are already paying over the minimum payments on their HELOC, the end of the draw period may only bring another expected monthly bill. But for those borrowers who have continued to make interest payments alone or taken out more credit – the monthly bill could potentially skyrocket. If those facing the higher bill are in a financially unstable place, they may be facing an increased possibility of default and by consequence – the loss of their home.
To avoid high levels of default, banks are now being urged to proactively check the financial stability of their borrowers, in hope they they will avoid the “money owed” shock once their payments go up.
Call To Action For Banks
The recent attention is a forewarning to banks as much as a reminder for borrowers. Though lenders have the house as collateral, they usually don’t want to force borrowers to default on their loans. Ideally, banks want their borrowers to remain in good financial standing so they can continue to make payments. As Marketplace reports:
Borrowers aren’t the only ones with concerns – banks are also working to make the transition a smooth one. “This is another bill coming due from the lending binge of the early 21st century,” says Retsinas. A bill that, according to the Office of the Comptroller of the Currency, now totals around $218 billion, of which $199 billion will be due by 2018.
In preparation, banks have been advised to work with borrowers and touch base before the principal payments are due. This could mean sharing repayment options or offering info on budgeting strategies.
Call To Action For Borrowers
Read up on your loan terms
Now is the time to refamiliarize yourself with your loan terms and double check that you’re up to date on the details. Even if you feel like you have a grasp on the situation, it never hurts to regularly revisit financial agreements to avoid confusion or financial shock.
Prepare for changes in your budget
Set up a plan of action for your repayment and take a look at how to restructure your budget to accommodate higher monthly payments. This may include pinpointing areas where you can decrease spending or brainstorming ways to increase your cash flow.
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If You Can’t Make Your Monthly Payment
Don’t ignore statements or bills
Feeling unprepared or unable to make payments is a scary thing but ignoring the issue won’t make it disappear. The best way to maintain authority over the challenge is to face your numbers and become an expert on your circumstances. This knowledge gives you the necessary insight into the ways you can attack the issue at hand effectively.
Communicate with your lender
Talk early and often with your lender if you anticipate a struggle to make payments. They may not have the solution but they can point you in the right direction and provide information and resources. Don’t be afraid to ask questions if you’re confused! Clarification over confusion – always.
Explore all your options
The best plan of action will vary depending on your specific circumstances so avoid going after a “fix-all” solution. Instead, research all options before making any definitive decisions!
Instances like these are yet another reminder of the importance of understanding the terms of your loan and continuing to check in as time goes by. Credit can feel abstract but your home is anything but! If you’re facing financial stress, you can take a look at our resource centers for info and tips.
Image Credit: Nick Amoscato