How do HELOC fixed-rate options work?

1
@5byseven/Twenty20

At Bankrate we strive to help you make smarter financial decisions. While we adhere to strict , this post may contain references to products from our partners. Here’s an explanation for

When you need extra funds, a home equity line of credit (HELOC) could be a lifesaver. A HELOC is a revolving line of credit that is guaranteed by your home’s equity, and you can borrow from it as needed.

Most HELOCs have variable rates, meaning the interest rate on your balance owed can rise and fall based on market conditions. However, more and more banks have begun offering fixed-rate HELOC options, where you can lock in an interest rate and potentially save money.

What is a fixed-rate HELOC?

A fixed-rate HELOC is considered 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 it works

With a fixed-rate HELOC, you can withdraw as much or as little of your credit line as needed and you’re able to convert all of that balance, or merely a portion of it, to the fixed interest rate.

Borrowers can usually convert their HELOCs to a fixed rate at closing or during the draw period, says Laura Sterling, vice president of marketing at Georgia’s Own Credit Union. “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 borrowers to take advantage of dropping 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 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

Because most traditional HELOCs come with interest rates that may fluctuate daily, they can result in a tremendous amount of uncertainty when you’re planning your monthly household budget.

“Be prepared for your payment to double every month or more, if the rate were to move up significantly,” says Mark Charnet, founder and CEO of American Prosperity Group, a retirement and estate planning firm.

A fixed-interest HELOC’s payment cannot fluctuate. However, fixed-rate HELOCs typically have higher starting interest rates than traditional HELOCs, Sterling says. There are also market factors to consider.

“Borrowers could be paying more than necessary for a fixed-rate HELOC if interest rates fall,” Sterling says.

Factors to consider with a fixed-rate HELOC

Fixed-rate HELOC options have their own pros and cons; consider these factors before applying.

Inflation

With inflation, a fixed-rate HELOC may be a smart move for your loan. If the market changes, you’re still protected by the rate that’s locked in on your loan.

“Inflation is a key variable that determines the interest rate environment,” Gupta says. “Inflation typically increases when the economy starts overheating and prices start increasing rapidly.”

Timeline

A fixed-rate option is also especially beneficial when your loan is meant for home improvements or other ongoing projects. With a fixed-rate loan, there is no hurry to begin construction before the interest 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,” Gupta says. “In that scenario, the customer will have full certainty about the cost of their financing.”

Cost

A HELOC doesn’t work for everyone. If interest rates rise quickly, you may not have time to lock in the lowest rate possible. Some lenders also require minimum amounts for a fixed-rate loan, so there is less flexibility for budget-conscious borrowers.

Hidden fees

There may also be hidden fees, such as penalties for an early draw or refinancing. Be sure to thoroughly review your HELOC’s terms to ensure that they work for you, because those penalties and fees can add up quickly.

“Borrowers may want to look out for annual fees and rate locks,” Sterling says. “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 withdraw amounts.”

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 you can go about it.

  1. 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.
  2. Refinance your old HELOC. Opening up a new hybrid HELOC allows you 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.

Here are some instances when it might make sense to convert your variable interest rate HELOC to a fixed rate.

Remodeling

A fixed-rate loan can be the perfect solution when remodeling a home. Throughout construction, your interest rates on a variable-rate HELOC could fluctuate, landing you at a higher rate while the renovation is in progress. When it comes to home renovations, converting part of your HELOC to a fixed rate protects you against rate fluctuations.

Family emergencies

Disaster often strikes without warning, and when it happens to your health, the expensive medical bills you’re left with could necessitate a loan. An unsecured emergency loan is one option, but a fixed-rate HELOC may be cheaper and easier to pay off.

Debt consolidation

Perhaps your oldest child went off to college this year right around the same time a tree fell onto your roof. There are two very important financial needs on your plate: preserving your child’s education and fixing your home. Unlike a debt consolidation loan, a fixed-rate HELOC doesn’t limit you to just one withdrawal. You can even take out a fixed-rate advance on the entire HELOC amount, and with the fixed interest rate, you’ll know exactly what your payments will be so you can plan for them.

Is a fixed-rate home equity loan option 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 yourself when considering which may be best:

  • 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,” Sterling says. “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 may give you more flexibility.
  • Are you comfortable with rates and payments that may change over time? “If the answer is no, a fixed-rate HELOC could be a good choice,” Sterling says.
  • How much money do you need to borrow? Remember, some lenders may require that you borrow a minimum amount if you want to lock in a fixed rate.

The ultimate goal is to borrow the money you need and pay as little as you can for it. A variable- or fixed-rate HELOC can get you there, especially if you keep an eye on the ever-changing financial market.

Learn more:

Written by
Natalie Campisi
Mortgage reporter
Natalie Campisi is a former mortgage reporter at Bankrate.
Edited by
Associate loans editor