Home equity lines of credit, or HELOCs, are revolving lines of credit backed by the equity in your home. Most HELOCs are variable-rate loans, which means the interest you pay can fluctuate up or down from month to month, depending on the market interest rate.
For those who are wary of variable-rate loans, some banks offer a hybrid HELOC that allows borrowers to switch all or some of their balance to a fixed rate.
“Fixed rates are great for consumers looking to create and stick to budgets. Particularly in a time when interest rates may start to rise, locking in a fixed rate is a big benefit and provides peace of mind,” says John Sweeney, head of wealth and asset management at Figure Technologies.
Opting for a fixed rate can be a smart move in a rising-rate environment. It’s also a good idea if you can lock in a low rate, as you’ll know exactly how much you owe every month without the worry that rates might go up.
The benefit of a HELOC is how flexible they are over a long period of time. A hybrid HELOC offers even more flexibility for people who want to fine tune what they pay and when. Most banks will let you go back to a variable rate if your needs change.
Here are a few scenarios that demonstrate how and when locking a rate might make sense.
Set aside a portion of your line of credit
Banks that offer hybrid HELOCs, like Wells Fargo, Bank of America and TD Bank, usually allow borrowers to convert either a portion or all of their loan from a variable to a fixed rate. You would then choose a term for paying the fixed-rate portion back. The terms available to you might depend on your financial institution or how much you borrow, but they can range from one year to 20 years.
You don’t want to pay more as interest rates rise during the construction, so you opt for a $25,000 advance on your HELOC with a fixed rate.
You could take out up to two or three fixed-rate advances on your HELOC to meet different needs. For instance, in addition to your home renovation, you might want to buy a $20,000 car and pay it off over five years. You could even take out a fixed-rate advance on the entire HELOC amount.
Pay down principal and interest at a fixed rate
With a traditional HELOC, you pay only interest during the initial draw period, which is typically 10 years. The loan amortizes, and after the draw period ends, you are required to pay interest and principal.
On the fixed-rate portion of a hybrid HELOC, you pay off both interest and principal during the term of the fixed rate, which could extend through the life of the HELOC.
As the fixed-rate advance is paid down, the amount paid off becomes available for use again as part of your credit line. If you have an outstanding balance on the credit line, you would continue to make interest-only payments on it during the draw period.
New loan application is not required, but rate is higher
Banks tout how easy it is to use a hybrid HELOC. Once you take out the loan, you simply choose to convert a portion of it into a fixed-rate advance without having to reapply for a loan.
The price you pay for this convenience is a higher interest rate than the variable rate you get with a traditional HELOC. But the fixed-rate lock does give you some certainty.
However, the longer the fixed-rate term you choose, the higher the interest rate.
Considering that variable rates also can move down, borrowers should ask lenders whether they can unlock the rate on a fixed-rate advance if that becomes more favorable at some point.
Before making a decision, HELOC borrowers should compare the variable and fixed-rate numbers to see what makes more sense on paper, says Joseph Polakovic, owner and CEO of Castle West Financial in San Diego. The variable-rate HELOC allows borrowers to pay down principal early, which eats into the source of big interest payments. The less principal you owe, the lower your interest payments.
“Dramatically speaking, even when the variable-rate grows past the fixed rate, it’s possible — despite the higher interest rate — that the actual amount of interest being paid at that time is lower due to the less outstanding principal being owed. So, even slow upward growth of rates favors the variable-rate option,” Polakovic points out.