Home equity lines of credit, or HELOCs, are variable-rate loans. But some banks offer a hybrid HELOC that allows borrowers to set aside a portion of the line for a fixed term and lock a fixed rate on it.
A HELOC with a fixed-rate option appeals to homeowners planning renovation projects. By locking the renovation money at a fixed rate, they don’t have to worry about rising rates.
Set aside a portion of your line of credit
Let’s say you take out a $100,000 HELOC and then decide that you want to renovate your home, a project that will cost $25,000. The contractor will be paid periodically over the span of the three-year project.
You don’t want to pay more as interest rates rise during the three years, so you opt for a $25,000 advance on your HELOC with a fixed rate.
“In today’s environment, customers are more and more choosing to improve their homes versus move, ” says Kelly Kockos, senior vice president of home equity at Wells Fargo. “And as their equity is rising, they are tapping into that equity to improve their homes. If they have a defined use for it, they are utilizing the fixed-rate advance to enjoy lower interest rates.”
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
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.
“A HELOC is typically a 20- or 30-year term. A lot of things might change over that time. This allows the customer — without having to spend more money for closing costs or fees or going through an application process — to continue to meet their borrowing needs over the entire life of their relationship with us,” says Rick Huard, senior vice president of consumer lending product management at TD Bank in the Portland, Maine, area.
Hybrid HELOC has a higher interest rate
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.
Matt Potere, CEO of Sunlight Financial in Charlotte, North Carolina, says interest rates on hybrid fixed-rate HELOCs vary, based on the borrower’s circumstances.
“… It’s typically based on their account characteristics, the size of the amount that they would be transitioning to a fixed rate, as well as factors such as where they live,” Potere says. “We look at the overall market and understand potential costs within a market.”
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.