Not Your Average Line of Credit

  • July 9, 2015

Millions of Americans have utilized lines of credit from banks and mortgage companies.  They are extremely popular and have been a real benefit to many.  Typically, interest payments are made monthly on the amount drawn from the line.  Principal can be paid down voluntarily as well.  And as you will see, sometimes involuntarily.

 

There are a number of caveats to be aware of with the traditional HELOC  (Home Equity Line of Credit).  Lenders are gun-shy these days after they bought in to the idea about 10 years ago that home values would continue to soar.  They were left holding the bag of course when millions of homeowners went “under water” in 2008.  A judicious assessment of the market instead of an unrealistic, even greedy one would have prevented a lot of losses for the lenders and borrowers.  So now, after the horse is out of the barn, lenders have swung the pendulum to the other extreme to protect themselves.  We wonder why they didn’t feel the need to act rationally ten years ago!

Back to those caveats.  Not only has qualifying for home loans in general become far more difficult, there are now call provisions and restrictions on HELOCS to minimize the lender’s risk.  When LTV (Loan to Value) gets too high, those restrictions or calls can be triggered.

There is another, brutal blow lurking that for many already has and for millions more is soon likely to cause a catastrophe.  This is the dreaded “R” word,  “Reset”.  This provision allows the lender at certain times (usually at five or ten year intervals) to reset the HELOC to become a fully amortizing loan, adding principal to the required payment.  Typically the payment will double or in many cases triple.  Imagine the effect on retirees on a fixed income whose $200 monthly interest payment on a HELOC now requires a payment of $500!  Do not dismiss this as an unlikely scenario.  It is happening right now and millions of HELOC borrowers are in line for a reset.  It will be big news in the media.  But it has always been in the fine print!

The lines of credit available through the HECM (Home Equity Conversion Mortgage) from the government have none of those disadvantages.  They also contain a remarkable feature whereby the unused funds actually increase in availability.  A HECM line of credit is a growing,  guaranteed source of tax free funds.  The unused portion grows at many times the interest that banks pay.  There is no other financial planning tool like it.  And no, it’s not too  good to be true.  One application of this eye-popping program is described here.