Dear Dr. Don,
When my wife and I first bought our home, we were forced to open a home equity line of credit because we only had 10 percent to put down. We are currently paying 7.59 percent fixed interest on a balance of $25,269.46 on this HELOC. It has been open since April 2004 and it's a 30-year term.
Because the prime rate is pretty low, I thought about switching to a variable-rate loan. Our existing loan allows us to switch back and forth without fees. In contacting Wells Fargo to see what our options are, we have been told that we can go to a variable rate 7.125 percent interest-only loan. This would make our monthly payments go from $279 to $150. We could continue to pay what we are today to knock off principal, but I'm worried about the potential for the variable rate to climb.
We have good credit scores (760 to 780) and debt-to-income ratios, and I'm wondering if we have better options to try and eliminate this debt at this rate. I have considered exercising the credit card transfer offers at low rates since we don't carry any balances on these $10,000 to $20,000 limits. I also considered trying to get an unsecured loan, but I'm not certain that it's feasible today. Any advice would be much appreciated.
-- Jason Juncture
The prime rate isn't likely to go much lower. It's currently at 3.25 percent. According to Federal Reserve statistics, the prime rate hasn't been this low since September 1955. Switching into a variable-rate loan that is less than 0.5 percent lower than your fixed-rate loan isn't a winning strategy, even if you can later switch back into a fixed rate. The issue is what the fixed rate will be when you want to switch back.
Most of the difference in your payments is because of the principal repayment component of the fixed-rate loan. Only about $10 of the difference in the monthly payment is because of the lower interest rate. If you plan on keeping up the principal repayments, there's not much incentive to switch to the variable-rate loan.
Your original home equity loan was no doubt part of a "piggyback loan" that let you avoid private mortgage insurance by keeping the loan-to-value of the first mortgage at or below 80 percent of the home's appraised value. With good income and credit, and strong front and back ratios, the limiting factor in refinancing your HELOC is the home's appraisal value. A low appraisal value can keep you from refinancing the second mortgage. Bankrate's national home equity loan averages are, at the time of this writing, 5.71 percent for a HELOC and 8.2 percent for a home equity loan.
An unsecured loan isn't the answer. A typical unsecured loan is at or near the average rate for credit cards. The rates, from Bankrate's national credit card rate averages, are 11.16 percent (standard variable) and 13.46 percent (standard fixed).
Using low-interest credit card offers can work. However, you're potentially giving up the mortgage interest deduction on your income taxes. You also may pay fees and run the risk that the promotional rate gets pulled out from under you. There's been some recent news of lenders raising minimum payment percentages on these low-rate offers, limiting the usefulness of the offer. Many of these offers are for balance transfers and not for an outright loan of funds.
So be very careful in pursuing a credit card strategy to refinance your home equity line. In general, you don't want to finance a long-term asset with a short-term loan.
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