A home equity line of credit (HELOC) can be a lifesaver. Whether you need cash to pay college tuition, remodel, pay off some credit card bills, student loan debt, or any reason, it's a go-to option for homeowners. According to the Equifax National Consumer Credit Trends Report, more than 285,700 new home equity lines of credit (HELOCs) were originated in Q1 2015, a year-over-year increase of 21.2 percent and the highest level since 2008. Nobody expects them to go out of fashion any time soon. For sure, the last several years of rock bottom low interest rates made HELOCs even more attractive.
Now, however, as interest rates are on the uptick, and are likely to continue upward, this impacts HELOCs.
Here's what you need to know.
Will Higher Rates Rock Your World?
When you have a variable interest rate on your HELOC, your monthly payments will change based on your balance and interest rate fluctuations.
Face reality. Open your HELOC statement and read the fine print. You should be able to find out how the rates will increase specifically for you. Most banks link HELOC rates to the Prime Lending Rate (PLR), which was 3.5% as of February 18. The PLR is linked to the Fed Funds target rate with a slight lag (Banks own the setting of the PLR), so one can track the Fed rate and can judge in real time how much higher their HELOC payments will be.
You could be in for a higher payment. An increase in rates by 1% would result in an additional $125 per month payment, assuming a $150,000 HELOC.
If you are one of the many people whose HELOC is resetting, the news could be worse. There is the real possibility of a devastating increase. After 10 years of your draw on the HELOC, it becomes a fully amortized 15-year loan, which some people don't fully understand. For example, a $100,000 HELOC at 4% would cost $333.33 in interest; but once that loan hits the 10 year mark, the payment would go up to $739.69 per month, points out Bijan Golkar, CEO of FPC Investment Advisory.
Don't Stress Out, Strategize
Take a historic look at rates and put them into perspective in today's market. It's been such a long time, but double digit interest rates were the norm. We've gotten spoiled. So all things considered, even a jump won't be what was average back in the day. Exhale. With rates already at such low levels, incremental increases won't take most HELOC rates into the territory of yesteryear.
Secondly, because rates aren't expected to rise quickly, time is on your side. Don't fritter away the opportunity to make a move. Speak to your lender about making your HELOC a home equity loan and lock in a fixed rate of interest. This should take care of any sleepless nights over rising rates.
Depending on how much you have left to pay off on your HELOC, consider too, balance transfer promotions. If you have a balance that you will be able to pay off within a year, you may be able to find a 0% interest rate balance transfer promotion with a 12-month window and pay off the balance that way.
Also, talk to your lender about the possibility of converting a portion of the outstanding variable-rate balance on your HELOC to a fixed rate.
If you have enough home equity, think about refinancing and getting cash out to pay off your first mortgage. This results in a new mortgage loan and payment amortization schedule which may have different terms than your original loan (type of loan, interest rate, longer/shorter time loan period).
Do be mindful of any fees associated with your HELOC. There may be upfront fees, such as an application fee, or an annual fee and a cancellation/early closure fee.
Investigate whether there are loyalty incentives with companies you already do business with. You may be eligible for discounts, like a mortgage relationship credit that you can use toward refinancing your loan.
The bottom line: you have options.
Protect Yourself, Just in Case
Truth is, any increase will not be welcome. Get a ballpark estimate of how much your new payment will be. Go over your household budget and see where you can cut expenses to make up for the increase. If simple cuts like a few less nights out on the town won't help much, come up with Plan B. Start formulating a strategy to bring in more income. Maybe it's time to make some money on your hobby, put in for overtime at work, or consider a part-time retail gig to avoid getting behind. Remember, with a home equity line of credit, your home is at stake. This is a bill you have to pay.
Should I Get a HELOC?
If you're interested in getting a HELOC for the first time, should you avoid doing so in this rising interest rate environment? The smart money is going on a HELOC with a fixed-rate option or a home equity loan.