Tuesday, September 1st, 2015
If your home equity line of credit is approaching its 10th birthday and you owe money on it, you might soon see a spike in the minimum monthly payments. There are ways to delay the payment increase by refinancing the loan.
A home equity line of credit, or HELOC, has two stages. First is the draw period, which usually lasts 10 years but can be as long as 20 years. Monthly payments are applied only to the interest during the draw period.
After the draw period ends, the second stage begins: The HELOC goes into the amortization period when you have to pay principal as well as interest. Monthly payments go up. If you still owe a lot, the payments rise abruptly. That’s why some homeowners look for ways to refinance their HELOCs.
3 options to refinance a HELOC
If you want to cushion the amortization period of a HELOC, there are three options:
Refinance the HELOC. When you refinance a home equity line of credit, you start over with a new HELOC, with its own interest-only draw period.
With this approach, you still have access to a credit line to deal with future needs. You will still have to pay off the balance someday. And since HELOCs have variable rates, nobody knows what rates will do a year from now.
Pay off the HELOC with a home equity loan. A home equity loan is for a fixed amount with a fixed rate. The payments remain the same through the life of the loan.
Refinance the HELOC and the first mortgage into a new primary mortgage. By refinancing the HELOC into a new primary mortgage, you could take advantage of a fixed interest rate that’s still low by historical standards. Consider refinancing into a 15- or 20-year mortgage to reduce total interest payments.
While interest rates on primary mortgages are favorable, you have to take higher closing costs into account when you take this approach. It’s best if you keep the house long enough for the cumulative monthly savings to outweigh the costs of refinancing.
Weigh all the costs
Home equity loans have much lower closing costs than primary mortgages. The disadvantage is that interest rates on equity loans are typically higher than on primary mortgages.
If you refinance into another HELOC, be aware of the heightened underwriting standards. Ten years ago, you could qualify on the basis of the interest-only payments. Today, you have to prove that you can afford the fully amortizing payments.
And if this is your first mortgage application since 2008, you might be surprised at how much documentation you will have to provide.