United States

Agencies issue guidance on HELOC repayment


An interagency group of federal and state financial regulators has issued guidance on managing HELOCs (home equity lines of credit) that are nearing their end-of-draw periods. As these loans move into the repayment phase, the transition may catch some borrowers unprepared and unable to meet the payment schedule. The purpose of this safety and soundness guidance is to help banks and credit unions manage the transition process, assist borrowers and thus, reduce risks and mitigate losses.

A HELOC is a line of credit that is secured by the property. It typically has a draw period followed by a repayment period. During the draw period, it functions as a revolving line of credit for the borrower, typically requiring only interest payments. During the repayment period, borrowers no longer have access to the revolving line of credit and must begin repayment of outstanding principal, either by paying the loan off immediately in a balloon payment or repaying it through higher monthly payments over the remaining term of the loan.

The guidance is being issued at a time when a wave of new HELOCs is on the verge of transitioning to their full repayment phases. Most borrowers will have no difficulty making the transition to the payment schedule. However, if property values have declined or the borrower's financial circumstances have changed, some may find themselves unable to afford the higher payments and higher interest rates. Either option can cause payment shock to the unprepared or financially strapped borrower and consequently, result in losses to the bank or credit union.

For those struggling borrowers, lenders should step forward to help them manage the transition. First and foremost, lenders should communicate to them clearly and effectively about what is expected.  Customers should be fully informed of the options open to them and understand their contractual obligation to repay the loan. If necessary, these customers should be offered workout and modification programs. The guidance states, "Management should structure end-of-draw' period renewal, workout, and modification programs to:

  • Base eligibility and payment terms on a thorough analysis of a borrower's financial condition and reasonable ability to repay
  • Provide payment terms that are sustainable and avoid unnecessary payment shock
  • Avoid modifications that do not amortize principal in an orderly and timely fashion.

As well, lenders should take steps within their own organization to ensure a better outcome for the loans.  Risk exposure should be reassessed so that remedial steps can be taken if necessary. Risks can be reduced by ensuring that customer service agents are adequately trained to work with financially-challenged HELOC customers. Underwriting guidelines and allowances for loan losses also should be reviewed to insure they are prudent and adequate. Accounting and reporting of modifications should be updated. Since regulators have stated that they intend to review the institution's HELOC risk management programs, it would be wise to check all internal policies and practices against this most recent guidance to insure the organization is in compliance.

The federal regulatory agencies issuing the guidance are the Office of the Comptroller of the Currency, the board of governors of the Federal Reserve System, the Federal Deposit Insurance Corporation and the National Credit Union Administration, along with the Conference of State Bank Supervisors. This guidance which is available for review at the website of the Federal Reserve System, lays out all the "need-to-know' information for banks and credit unions who are managing the transition to the HELOC's repayment phase.