|Home equity lines of credit: Keep
If you have a home equity line
of credit, maybe you wonder what to do with it. Should you keep
the credit line, even though the rate has almost doubled in 21 months?
Should you refinance it? To answer, you will have to make a judgment
call and probably do some math.
Two years ago, a home equity line of credit looked
like a great deal. Credit lines gave homeowners access to money
at rates that were lower than those on fixed-rate home equity loans
or first-lien mortgages. Cheap credit lines allowed borrowers to
use their homes as ATMs to pay for home improvements, college tuition,
cars and vacations.
But credit lines are indexed to the prime rate, and
that means that borrowers' minimum monthly payments go up whenever
the Federal Reserve raises short-term rates. The Fed has done so
15 times since the middle of 2004, raising the prime rate from 4
percent to 7.75 percent. Most observers expect the Fed to hike at
least once more.
Monthly payment nearly doubles
The increases have hit consumers' checkbooks hard.
the hypothetical example of someone who borrowed $30,000 against
a home equity credit line when the rate was 4 percent. Two years
later, the same borrower still owes $30,000 because she has made
only the minimum payments, which cover interest and not principal.
Now that the rate is 7.75 percent, the minimum monthly
payment has risen from $100 to $193.75.
Credit lines are no longer the great deals they once
were. The average rate on a credit line is now higher than the average
fixed-rate home equity loan. And 30-year, fixed-rate mortgages are
Borrowers have three options:
- Keep the credit line.
- Pay it off and replace it with a fixed-rate home
- Do a cash-out refinance on the first-lien mortgage
and pay off the credit line with the proceeds.
Holding the (credit) line
A credit line has two advantages, says Michael Moskowitz, president
of Equity Now, a mortgage lender in New York: It grants you flexibility,
and you pay interest on the amount owed and nothing more. If those
qualities are important, you might want to keep the credit line.
The archetypical user of a home equity line of credit,
Moskowitz says (and, yes, he uses the word "archetypical"),
is a self-employed homeowner "whose business goes up and down
and they want to have in reserve a couple of hundred thousand dollars."
The ready reserve of money helps smooth out the times when not a
lot of money is flowing in.
That archetype has expanded to include people who
need to borrow money periodically, using their house like a credit
card -- homeowners who renovate their homes in stages, for example,
or parents who pay tuition. For these people, the flexibility of
a credit line outweighs the rising interest rate.
Ideally, these borrowers draw from their credit lines
and then pay some or all of the balance before drawing against the
credit line again. Using a credit line this way is cheaper than
using a credit card, and the interest is tax-deductible.
"If they're not fully drawn out, and expect
money to go in and out, they keep a home equity line of credit even
though rates will keep going up," Moskowitz says.
On the other hand, someone who carries a balance
on a credit line might want to embrace the discipline of being forced
to pay it off, even if it's at a higher rate.
Refinancing into a fixed loan
If you can stand the higher payments, it might make sense to refinance
the credit line into a fixed-rate home equity loan, says Anthony
LaGiglia, a financial planner with J.J. Burns & Co. in Melville,
N.Y. Right now, rates on home equity loans are roughly the same
as those on home equity lines of credit. But home equity loans sport
higher payments because the minimum payment includes interest and
principal, and not just interest.