Most home equity line of credit (HELOC) loans are indexed to the bank prime loan rate. This means that when the prime rate changes, the rate on your HELOC loan will change too, typically within a few weeks time.
When prime increases 100 basis points (one full percent) the typical home equity line of credit borrower with a $30,000 balance, pays an additional $300 in yearly interest costs. If you make monthly payments according to a fixed schedule, the rise in rates also means less of each payment dollar goes towards reducing principal. In other words, it will take longer to pay off the loan balance. Interest rates seem likely to continue rising (at least in the short run so it is worthwhile to look at some strategies available to HELOC borrowers to help control the damage to their wallet:
1. 0% Balance Transfer Offers – If you have good credit and are attentive to details, transferring some or all of your HELOC debt to a 0% credit card can be a viable strategy. You can ride the 0% offer until it expires knowing that you can always payoff the balance with a HELOC check (effectively transferring the balance back to the HELOC). A few downsides of this strategy are:
a) minimum monthly payments will be 2% – 3% of the balance which may be higher than the minimum payment for an interest-only HELOC;
b) you must be on top of all the details related to the 0% offer. For example, Discover offers a “0% for life balance transfer, but you must be certain to make a minimum number of purchases each billing cycle to keep the 0% rate. Trip up and your rate can immediately skyrocket to double-digits; and,
c) most offers have a balance transfer fee associated with them. Typically, the fee is 3% – 5% of the transferred balance with a maximum (e.g. $50.00). Be sure you know exactly what the transfer fee is and that the interest savings you expect to realize will easily offset it. It is worthwhile calling the credit card company to discuss their balance transfer fee. Account reps often have discretion to waive the fee if they think doing so will close the deal.
Theres no free lunch with this strategy, but if you are willing to put in the effort, you can realize significant interest savings.
2. You can also refinance or roll your HELOC into a fixed rate home equity loan or your first mortage . This will protect you from further rate increases – but can backfire if rates fall again. In the current market, longer-term fixed rate loans have not risen in step with increases in the prime rate. This makes this an attractive option for some.
A key factor if you are considering this move is to carefully analyze the up front closing costs of the refinancing transaction and determine whether you will remain in the home long enough to recoup these costs through interest savings.
3. Perhaps the simplest, most effective strategy is to inventory your cash assets and pay down the debt. If you have cash sitting in CDs, money market accounts or other investments earning less than the rate on your HELOC, consider using that cash to pay down the interest-accruing balance on your HELOC. You can still get the funds out in an emergency by simply writing a HELOC check.
Be sure you consider the effective after tax rate on your HELOC when comparing rates.
4. Review the terms of your HELOC with your banker. Things you should be familiar with include the specific index and margin used (e.g. prime rate -.25% frequency of rate changes – monthly, quarterly, etc. (less frequent is better when rates are rising and the lifetime cap on your rate.
If you have had the same HELOC for several years, you might find you a have a relatively low cap. Some HELOCs originated 4-5 years ago have lifetime caps as low as 7%. Also, find out if your HELOC permits a conversion to a fixed rate home equity loan with little or no closing costs.
5. Ask your lender if there are any rate discounts available. For example, some credit unions offer to discount your rate by a quarter percent (0.25%) if you have monthly payments automatically deducted from a checking account. Other discounts may be available if you have a significant service relationship (e.g. checking, savings, CD, business accounts, etc.) with the bank.
6. Look for a better HELOC deal. The market remains very competitive with many lenders offering sub prime rates with low or zero closing costs. Shop the internet and shop your local lenders to find the best HELOC deal. And dont be shy about letting your current lender know that you are shopping – if you have a banking relationship they value, you may find them very willing to give you special consideration.
Rising interest rates are a cyclical fact of financial life. The good news is that even with recent increases, HELOC rates are still at historically low levels. Furthermore, the tax-deductibility of interest keeps the HELOC loan the most cost-effective method of borrowing for the savvy consumer.
