How does a fixed-rate HELOC work?
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You might know how a typical home equity line of credit (HELOC) works — functioning as a revolving line of credit secured by your home’s equity. A fixed-rate HELOC works a little differently.
What is a fixed-rate HELOC?
A fixed-rate HELOC is a hybrid of a home equity loan and a HELOC. It allows you to lock in a portion or all of your balance at a fixed interest rate, protecting you against market fluctuations that impact rates.
How a fixed-rate HELOC works
With a fixed-rate HELOC, you can withdraw as much or as little of your credit line as needed. Unlike a variable-rate HELOC, the interest rate on any amount you use will have the same interest rate applied throughout the draw period.
If this option exists for your HELOC, you can usually do the conversion at closing or during the draw period, says Laura Sterling, vice president of Marketing at Georgia’s Own Credit Union, adding that “Some lenders may also allow the borrower to convert back to a variable rate.
The ability to switch back and forth between variable and fixed rates allows you to take advantage of lower interest rates when they become available. At the same time, locking in a fixed interest rate can provide the stability of predictable monthly payments.
The fixed-rate portion of the HELOC can be locked in for terms ranging from five years to 30 years, during which time the loan is paid back like a typical mortgage, says Vikram Gupta, executive vice president and head of Home Equity at PNC Bank.
Fixed- vs. variable-rate HELOC
A variable-rate HELOC translates to some uncertainty when planning your monthly household budget. A fixed-interest HELOC’s payment can’t fluctuate.
However, fixed-rate HELOCs typically have higher starting interest rates than traditional HELOCs, says Sterling. Fixed-rate HELOCs also might charge higher fees than a traditional HELOC, or impose limits on borrowing that you won’t have with a variable-rate HELOC.
Factors to consider with a fixed-rate HELOC
In terms of inflation, a fixed-rate HELOC might be the smarter move. That’s because regardless of what happens with the economy, inflation and interest rates, you’ll still have the security of a fixed rate.
Case in point: The Federal Reserve raised its key rate several times in 2022 to combat elevated inflation. This led to higher interest on variable-rate financial products, including HELOCs
The flip side is also true, however: If prevailing market rates drop, you might not be able to easily convert back to a variable rate and get a lower payment. The bottom line: Take your budget and risk tolerance into consideration.
A fixed rate can be especially beneficial if you’re using the HELOC to make home improvements. That’s because there’s no hurry to begin remodeling before the rate increases.
“Establishing a fixed-rate lock on a HELOC can often make sense when a customer has a planned expense they need to finance, such as a home renovation project,” says Gupta. “In that scenario, the customer will have full certainty about the cost of their financing.”
A fixed-rate HELOC might also come in handy in an emergency, such as an unforeseen medical bill, or to consolidate debt.
Cost and fees
While a fixed-rate HELOC lends certainty to your budget, there’s no telling how interest rates might change in the future. If rates fall, you might find you were better off with a variable-rate line of credit.
There might also be hidden fees, such as penalties for paying the line off early or a fee for exercising the conversion option.
“Borrowers may want to look out for annual fees and rate locks,” says Sterling. “Some lenders cap the number of fixed-rate locks that a borrower can do annually and may charge a fee for each rate lock. Borrowers should also be aware of minimum withdrawal amounts.”
Minimum borrowing requirements
In order to get the fixed rate, your lender might require you to draw a minimum amount from your HELOC. This might not work well for you if you’re trying to stay within a certain budget.
Can I convert an existing HELOC to a fixed rate?
If you’ve taken out a variable-rate HELOC and want to convert to a fixed rate, there are a couple ways to go about it:
- Open a new hybrid HELOC. The simplest way to get a fixed-rate HELOC is to take out a new HELOC altogether. This is best if you’re near the end of the draw period for your current HELOC.
- Refinance your old HELOC. If you open up a new hybrid HELOC, you can use it to refinance your existing HELOC — you’ll simply pay off the balance of your old HELOC using funds from your new HELOC. This will also reset your draw period.
Is a fixed-rate HELOC best for me?
Whether it’s a home renovation project or a large unexpected expense, it’s a good idea to examine both variable-rate and fixed-rate HELOC options carefully to determine which one makes sense for you. Both have their benefits; it’s just a matter of your needs. Here are some questions to ask:
- Is it a rising or falling rate market? “If you are in a rising rate market, a fixed-rate HELOC could be a good option,” says Sterling. “If you anticipate rates remaining low, you may save more with a traditional HELOC.”
- Is there a set amount you need to borrow? Are you paying off a student loan or do you need flexibility in the amount you are borrowing for a large or ongoing home improvement project? Fixed-rate HELOCs might give you more flexibility; however, some lenders require that you borrow a minimum amount to lock in the rate.
- Are you comfortable with rates and payments that could change over time? “If the answer is no, a fixed-rate HELOC could be a good choice,” says Sterling. A traditional variable-rate HELOC will have a different interest rate depending on the market.