When you need extra funds, a home equity line of credit 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. It’s important to know, though, that there are two different types of HELOCs: a fixed-rate HELOC and variable-rate HELOCs, and the difference between the two could mean spending, or saving, more money on interest.
Most HELOCs are variable-rate loans, so the interest rate fluctuates in response to the market. These fluctuations then affect your payment, determining how much you pay each month. But there are also HELOCs with fixed rates, which means your line of credit has the interest rate locked in, so it won’t fluctuate from month to month.
What is a fixed-rate HELOC?
In times of uncertainty, borrowers tend to favor HELOCs with fixed rates for their home equity line of credit. Knowing what the interest will be from month to month provides consistency and peace of mind. There are times when a fixed-rate loan is especially beneficial — in cases of tight budgets, for example — and it remains a preferred choice by many borrowers.
Some banks allow you to switch some or all of your loan to a hybrid HELOC. A hybrid HELOC allows you greater flexibility, allowing you to make adjustments throughout the life of the loan. Most banks will even allow you to switch back to a variable rate, should your needs change. If you prefer to know what your payment will be from month to month but don’t want to miss out on lower interest, a hybrid HELOC could be the perfect solution for you
Pros and cons of a fixed-rate HELOC
When considering a fixed-rate HELOC loan, there are some key factors to consider.
With inflation, fixed-rate home equity lines of credit may be a smart move for your loan. If the market changes, you are still protected by the rate you locked in with your loan.
“Fixed rates are great for consumers looking to create and stick to budgets,” John Sweeney, the head of wealth management and asset management at Figure Technologies, said. “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.”
It’s also especially beneficial when your loan is for home improvements. With a fixed-rate loan, there is no hurry to begin construction before the interest rate increases.
Higher interest rates
A HELOC does not work for everyone. Interest rates still top conventional loans, so homeowners pay more than other types of loans. Some lenders require minimum amounts for a fixed-rate loan, so there is less flexibility for budget-conscious borrowers.
There also may be hidden fees that include penalties for an early draw or refinancing. Be sure to thoroughly review your HELOC to ensure the terms work for you, because those penalties and fees can add up quickly.
Recommended situations to convert a HELOC to a fixed-rate
There are times when converting a variable HELOC to a fixed-rate option is the best choice. Whether it’s a home renovation project or just the need for a large sum of money, it would be wise to examine both variable-rate and fixed-rate options to make the right decision for your needs.
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, a fixed-rate loan would be a better option, since a hybrid or variable HELOC could experience market changes and end up costing you more than your initial rate.
Disaster often strikes without warning, and when it happens to your health, the expensive medical bills you’re left with could necessitate a loan. It will take time to pay these off, so a fixed-rate HELOC ensures that you won’t fall victim to inflation while you’re putting the pieces back together at home.
Payment in full
With a traditional HELOC, you only pay on the interest during the initial draw period, which is typically 10 years. The loan amoritizes, and after the draw period ends, you are required to pay both the interest and principal. A fixed-rate, however, allows you to make payments on the interest and principal throughout the term. As you make payments toward your fixed-rate advance, those payments are credited back to your credit line and are available for use again. This allows you the opportunity to pay your balances off faster, so you don’t pay as much in interest in the long run.
Satisfy multiple debts
Perhaps your oldest child went off to college this year — which was right around the same time your roof fell in from unexpected weather issues. There are two very important financial needs on your plate: fixing your home and preserving your child’s education. A fixed-rate HELOC does not limit you to just one withdrawal — you can take up to three. 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.
How to convert your HELOC to a fixed-rate
If you’ve taken out a variable rate HELOC and want to convert it to a fixed rate, there are options.
Consider opening a new hybrid HELOC
Banks tout the benefits of a hybrid HELOC, but not everyone is familiar with the concept. When you take out a new hybrid HELOC loan, you have the option of converting a portion of that loan into a fixed-rate advance. By combining the process, you do not have to reapply for a loan and repeat the whole application process.
You can do this even if you already have another HELOC; you’ll have to go through the same process as before, but opening a new hybrid or fixed rate HELOC will help you restart the draw period and solidify your interest rate.
The convenience of a fixed rate HELOC can be a gamble, however. You could end up with a higher interest rate than the variable rate you would normally receive with a traditional HELOC. Before accepting a loan, consider the length of your term. The longer your term, the higher the interest on your fixed-rate loan.
Still, a fixed-rate offers more certainty and stability that does not come with a variable rate, even if you end up paying a little more in the long run.
Ask to convert your loan at a time when variable rates have decreased
Variable rates can also decrease, so borrowers should ask lenders whether they can switch to a fixed-rate advance should that become more beneficial.
“Before making a decision, HELOC borrowers should compare the variable and fixed-rate numbers to see what makes more sense on paper,” advises Joseph Polakovic, owner and CEO of Castle West Financial in San Diego.
The variable-rate HELOC allows borrowers to pay down the principal early, reducing the significant interest payments that can accumulate on your loan. The less principal you owe, the lower your interest payments will be.
“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.
Apply to refinance your HELOC
If you want to convert your variable-rate HELOC to a fixed rate loan, you may be able to do so by refinancing your loan. The process is similar to applying for a mortgage loan or a new HELOC — you’ll need all of the documents the underwriters deem necessary, and you’ll need a good credit score — but if you are approved for a refi, your new fixed rate could save you a ton of money in the long run.
The bottom line
You have options when you need a home equity line of credit. Both variable and fixed-rate loans have their benefits — it’s just a matter of your needs. 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 tides of the financial market.