2011 Interest Rate Forecast » Sobering rate forecast on equity loans
If you have a home equity line of credit, or HELOC, the low-rate ride has just about ebbed. Experts expect interest rates, which receded to all-time lows near the end of 2010, will increase this year.
The quandary for consumers: How high will the tide rise? HELOC rates are affected by a number of factors, particularly the short-term interest rate policy of the Federal Reserve. The Fed has said it believes keeping short-term rates near zero is good for the economy, at least for now.
If the recovery gets hot enough to spark inflation, however, the Fed will likely have to douse it by raising rates. The direction of HELOCs then depends on how long, and how strong, the recovery turns out to be. And it could mean considerable consumer pain.
"Home equity lines of credit are not mortgages, they are more like a big, giant credit card," says John Sauro, president of North Atlantic Mortgage Corp. in Stamford, Conn. "When rates go up, it's going to get pretty bad."
How much is hard to say, but Sauro believes a HELOC with a 4.5 percent rate now could easily climb to 7 percent or 8 percent during the next 24 months, significantly affecting monthly payments. At 4.5 percent, interest-only payments on a $30,000 HELOC balance are $112.50 per month. At 8 percent, the payment would be $200.
As important as rates, meanwhile, is availability. Consumers with top-notch credit and a good amount of equity in their homes should continue to qualify for HELOCs. Unfortunately, as the country enters 2011, the Great Recession has reduced the ranks of HELOC-worthy customers, says Dani Zabala, a former banker who founded the website GetBankSmart.com.
"For borrowers with prime credit quality, the willingness by banks to lend is picking up again," he says. "But for nonprime borrowers, the well seems pretty dry." Zabala says that banks want to see a credit score of 720 or higher. And in stark contrast to the days of no-documentation loans, banks now want certified tax returns, pay stubs, W-2s and 1099s to verify income.
A HELOC is, simply, a revolving line of credit for which your home serves as collateral. It generally has a variable rate, often tied to the prime rate. HELOCs have a credit limit, and many have a draw period, such as 10 years, during which you can access the money. They offer lower rates than, say credit cards, and the interest is usually deductible.
Many HELOCs are "interest only" during the draw period, after which you must begin repaying what you borrowed. The hazardous combination of rising rates just as principal repayment begins is what concerns Sauro. "Your payment is going to go up with a variable rate loan and it could go up a lot," he says.
If that scenario makes you uneasy, Sauro suggests you start strategizing now. One option is refinancing your home and paying off your HELOC with the new mortgage. If you do it now, while fixed rates are still relatively low, you won't have to worry about interest rates rising later.
You could also consider a home equity loan with a fixed rate, although rates are typically considerably higher than a HELOC. Still, you'll know exactly what your payment obligation is for the entire life of the loan.
Bankrate has a comprehensive analysis of where all sorts of interest rates are likely headed in 2011, and how these moves will affect you. Go to 2011 Interest Rate Forecast to view the full report.
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