If you are currently considering a home equity credit line or are considering refinancing a HELOC (See the latest HELOC prices for which you can qualify here), you may want to ask about a fixed rate option. Below, we explain what this is and why it can be valuable to borrowers right now.
What is HELOC and how does HELOC work?
But first, you need to understand the basics of a HELOC. HELOC is a line of credit, borrowed against equity in one’s home, where the home is used as collateral for the debt. They usually have 30 year terms, of which there is a 10 year draw period and a 20 year repayment period. The withdrawal period is when the borrower is allowed to withdraw from his credit line and during this period, which is usually 10 years, the borrower is usually required to pay only the interest on the loan. At the end of the withdrawal period, the borrower can no longer use the credit limit and must repay the balance of the loan, including both principal and interest. This repayment period usually lasts 20 years.
HELOCs are generally variable rate products, which means that their interest rates fluctuate based on the original interest rate. But not all HELOCs are binding on a variable rate structure and this may be important to consider in this low rate environment (See the latest HELOC prices for which you can qualify here).
ONE Fixed interest rate selection in a HELOC
When shopping for a HELOC, Greg McBride, chief financial analyst at Bankrate, says it’s important to ask lenders if they allow the option to set the interest rate on a outstanding balance. This allows the borrower to lock in a portion of the outstanding balance at a flat rate or the ability to convert a HELOC to a flat rate after the draw period. “This can be attractive if you want to refinance an existing floating rate HELOC or expect to borrow all the money fast enough and want to lock in the interest rate,” says McBride.
A fixed interest rate also means that the monthly payment on your existing balance will not change, which can be valuable in terms of budget, as it offers more certainty about the cost of additional borrowing during the draw period. “Especially with interest rates that are ready for recurring increases over the next two to three years, a variable interest rate can create a lot of uncertainty about what it will cost and how your payments will be in the coming months and years,” says McBride.
If you enter into a floating rate HELOC and want to convert it to a fixed rate due to home renovation, family emergency or debt consolidation, you can either open a new HELOC or refinance your old HELOC by repaying the rest of the old loan and using the loan the new fixed rate loan at which your lottery period would be zeroed.
Because interest rates are likely to rise over the next two years according to economists and may rise faster than we have seen in recent history, fixed rate HELOCs are particularly attractive right now, say professionals (See the latest HELOC prices for which you can qualify here). But as the saying goes, “there is no free lunch”, so a fixed interest rate HELOC can result in higher charges or penalties for closing early or have a higher interest rate at the beginning, as the lender bears the risk of higher interest rates at future, “says McBride.
Marguerita Cheng, certified financial programmer and CEO of Blue Ocean Global Wealth, says the biggest benefit of a fixed interest rate HELOC is the calm of an interest rate that will not fluctuate. “In the short term, it may be higher than the variable but [you should still] “Pursue it if you want stability and predictability,” says Cheng. This, he says, is because you do not want to have a large HELOC balance with variable and floating payouts.
Fixed price HELOCs can also be a good choice for homeowners who want to pay for home improvements instead of trying their luck at buying a new home in today’s competitive home market.
So should or should not you pursue a fixed rate HELOC? Basically, if the prospect of a variable interest rate and the possibility of higher interest rates lead to higher monthly payments that would put pressure on your budget, it is wise to look for a fixed interest rate that can mitigate this uncertainty. “The interest rate may be higher than if you raised a variable interest rate, but that could pay off if interest rates rise significantly over the next two years,” says McBride.
Is a mortgage or HELOC the right choice for you?
Housing equity loans have fixed payments and interest rates and a lump sum upfront, while HELOCs offer recyclable credit limits, floating payments and a limited time to repay the loan (known as the withdrawal period). If you know exactly how much money you need for a particular reason, a home equity loan may make more sense than a HELOC, which provides the option of borrowing for a longer period of time.
Advantages and disadvantages of a HELOC and for what purpose to use a HELOC
Although a viable option for many, applying for HELOC is not cheap. The initial cost can include an application fee, title search and appraisal that can cost hundreds of dollars, so if you are looking for a small loan, there may be a better solution. And if you do not repay your HELOC, it may mean that you will lose your home.
Professionals say some of the best uses for a HELOC include home improvement projects, paying for medical expenses or consolidating high interest rate debt (See the latest HELOC prices for which you can qualify here). But experts advise you to avoid a HELOC for discreet expenses.