Dear Dr. Don,
I have a home equity loan (not a line of credit) around $90,000 at a variable rate of 2.55 percent. The lender requires me to convert it to “fixed-rate home equity loan” in the next 18 months. Will the home equity loan’s fixed rate be high? Should I convert the loan right now or wait and convert later? Do I have any other alternatives?
— David Dilemma
It’s pretty unusual to have a variable-rate home equity loan. Some lenders offer a hybrid loan, which behaves like a home equity line in the early years of the loan and then converts to a home equity loan. The Bankrate feature “Line blurs between home equity loans, lines of credit” explains the hybrid loans.
Regardless, you’re in a position where your variable-rate loan is going to convert to a fixed-rate loan. Your variable-rate loan is at a competitive 2.55 percent at a time when Bankrate’s national average for a fixed-rate home equity loan is at 8.51 percent and a home equity line of credit is a variable 5.67 percent.
You’re in a classic dilemma. You want to stay in the low rate for as long as possible, but you see interest rates heading higher. The trade-off is between converting now and locking in a lower fixed rate, or converting later and keeping the low variable rate for as long as you can before converting to the higher fixed rate.
Review your loan documents to determine how the lender sets the fixed rate when you convert it from a variable rate. If you can’t find it, or found it and don’t understand it, talk to your lender. Understanding how the lender will price the fixed rate will help you decide when to convert.
Depending on the appraised value of your home and any other mortgage debt outstanding, you have options. You could consider a cash-out refinancing of your first mortgage to pay off the existing home equity loan and refinance an existing first mortgage. You can also look into replacing the existing loan with a new home equity line or loan. Make sure there’s no prepayment penalty on the existing loan before pursuing these options.
You also want to consider how long you plan on being in the home. If you’re a short-timer, it’s likely better to stand pat and let the loan convert in 18 months. I’d define short-timer as someone who plans to be in the house for another one to three years.
Read more Dr. Don columns for additional personal finance advice.