On July 1, 2014 the federal financial institution regulatory agencies published guidance regarding the risk associated with Home Equity Lines of Credit (HELOCs) transitioning from their draw periods to full repayment. This is not a new issue. HELOCs have been part of product mix for financial institutions since the 1980s.
Most HELOCs have a five or ten year draw period. During the draw period, a borrower has revolving access to unused amounts under a specified line of credit. The draw period is followed by a repayment period. During the repayment period, borrowers can no longer draw on the line of credit, and the outstanding principal is either due immediately in a balloon payment or is repaid over the remaining loan term. Higher monthly payments during the repayment period may result in problems.
Most creditors renew or refinance the HELOC as the draw period comes to an end. Normally this is a smooth process, but in some cases borrowers may have difficulty meeting higher payments resulting from principal amortization or interest rate reset, or renewing existing loans due to changes in their financial circumstances or declines in property values. These are the situations addressed by the interagency guidance.
The interagency guidance:
- Describes core operating principles that should govern management’s oversight of HELOCs nearing their end-of-draw periods.
- Describes components of a risk management approach that promotes an understanding of potential exposures and consistent, effective responses to HELOC borrowers who may be unable to meet contractual obligations
- Highlights concepts related to financial reporting for HELOCs.
A copy of the interagency guidance is available here.