If you’ve got a home equity line of credit, or HELOC, let the economic upset from coronavirus serve as your wakeup call. If you’re thinking about opening a HELOC or consolidating your debt with a mortgage refinance, the alarm is ringing as well.
Your HELOC rate likely has plunged as low as it’s ever going to get, so now is the time to take a hard look at the terms of your HELOC and decide if you should keep it, or if you should ditch it by refinancing the balance into a new fixed-rate mortgage.
The coronavirus pandemic has led to an economic calamity that has slashed interest rates for financial products of all types, and home equity lines of credit are no exception.
The cost of a HELOC typically is tied to the prime rate. And prime has plummeted in recent weeks, falling to just 3.25 percent in April, down from 4.75 percent in early March. The prime has been this low only a couple of times over the past 60-plus years.
A HELOC works like a credit card: You can borrow from the credit line as the need arises, pay it off in installments, then reuse the credit as you like. However, the interest is often much lower than you’d find on credit cards, so many homeowners turn to HELOCs when they need large sums of cash. The interest may be tax deductible as well, if you use the money to improve your home.
For borrowers with stellar credit, HELOC lenders charge a point or so over the prime rate, meaning this form of money is available for as little as 4.25 percent. Borrowers with riskier profiles, such as lower credit scores or higher loan-to-value ratios, might pay 1.5 or 2 points above prime.
Sure, HELOCs are historically cheap, but money is cheap to borrow in general, as the Federal Reserve cut its fed funds rate to zero in an effort to save the economy from the coronavirus. Even so, HELOCs remain more expensive than other forms of credit. A 30-year fixed-rate mortgage cost an average of 3.58 percent this week. A loan through the federal government’s Paycheck Protection Program carries an interest rate of just 1 percent.
Home equity can be a lifeline in a pinch, but beware
In times of economic uncertainty, HELOCs can be a financial lifeline, but they also can prove risky for borrowers. Their variable rates can take large swings because they are reset monthly — and, if home values fall or borrowers lose income, lenders can freeze HELOC accounts, something that happened commonly during the Great Recession.
“People couldn’t get the money when they needed it most,” says Ed Conarchy, a mortgage adviser at Cherry Creek Mortgage Co. in Gurnee, Illinois.
Some say the savviest move is to pay down your HELOC, or to roll the balance into a refinance with a cheaper traditional mortgage.
“If the consumer has the choice, the risks are much less on a 30-year fixed first mortgage than on a HELOC,” Conarchy says.
What’s more, landing a HELOC isn’t easy at the moment. Megabanks Chase and Wells Fargo, two big players in the HELOC market, have pulled back. Other lenders have followed suit, bumping up requirements for credit scores and loan-to-value ratios.
But there are instances where a HELOC makes sense, mortgage experts say.
A HELOC is a better deal than carrying a credit card balance
Say your bank charges you 1.5 points over the prime rate for your HELOC, or 4.75 percent as of early April. That sounds a little expensive compared with a traditional mortgage.
But, says Jim Sahnger, mortgage planner at C2 Financial Corp. in Jupiter, Florida: “It’s less than a charge card.”
Carrying a balance on a credit card will mean paying double-digit interest rates, so a HELOC clearly comes in as the better alternative. The average rate for a credit card nationwide is 16.64 percent, according to Bankrate data.
If you’re carrying $20,000 in credit card debt at 15 percent and you have plenty of home equity, a HELOC can be a no-brainer. One caveat: Be sure not to simply run up more credit card debt after rolling your balances into a HELOC.
Here are four things you can do to manage your debt, with or without a HELOC :
1. Use a HELOC as a source of emergency funds
A HELOC is a line of credit that you can tap when you need it. If you have a $100,000 HELOC and you don’t need the money, you pay no interest.
If your stock portfolio has dwindled and your income suddenly looks precarious, a HELOC can provide a safety net.
Fees vary by lender, but they tend to be modest. Some lenders charge $100 a year for an untapped HELOC; others charge nothing. (If you’re taking out a HELOC for the first time, you’ll have to pay for an appraisal and other costs.)
Because of the HELOC’s low costs, says Rocke Andrews, broker-owner at Lending Arizona in Tucson and president of the National Association of Mortgage Brokers, “It’s a great backup.”
Getting approved for a HELOC isn’t automatic. If you’ve already lost your job, it might be too late to tap your home equity at favorable terms.
2. Consider a cash-out mortgage refi instead of a HELOC
Another possibility is to use a cash-out refinance to retire your existing HELOC, or to retire other higher-interest debt. A cash-out refinance replaces your current home loan with a new mortgage that’s greater than your outstanding loan balance. You withdraw the difference between the two mortgages in cash and use the proceeds to pay off the HELOC, or other debts.
This is an option only if you have built up plenty of equity in your home, and if your income hasn’t been hammered by the economic slowdown.
In addition, you must make sure the considerable costs of refinancing can be recouped in the time you plan to own the house. Our mortgage refinance calculator can help you with that decision.
3. Take a closer look at your existing HELOC
Amid the coronavirus crisis, this is an ideal time to examine the details of your HELOC. Look at your statement this month — it’s likely to show the lowest rate you’re ever going to pay. That’s because the prime rate hasn’t been this low since 2015, when it matched its 1954 low of 3.25 percent.
If you’re impressed by your rock-bottom rate, congratulations. However, if you didn’t get a great deal on your current HELOC, then now is the time to take action — either by refinancing into a new HELOC with better terms, by shifting that balance into a fixed-rate home equity loan or doing a refi of your main mortgage and wrapping in the HELOC, if that makes sense financially.
4. Use a HELOC for a jumbo loan workaround
In much of the country, mortgage giants Fannie Mae and Freddie Mac will buy mortgages of up to $510,400, known as the conforming limit. In high-cost housing markets such as Los Angeles, New York City and San Francisco, the limit for a conforming loan for 2020 is $765,600.
Borrow more than that, and you’ll need a jumbo loan. However, the global pandemic has caused many lenders to tighten their purse strings.
“Jumbo lending has dried up,” Andrews says. Lenders simply don’t want to take the risk of these large loans defaulting at a time when they can’t find buyers who’ll buy the bundles of securities tied to a jumbo portfolio.
In this case, a HELOC might be the solution. Say you’re buying a $710,000 home in a market with a loan limit of $510,400, and you have $100,000 for the down payment. Andrews advisies taking a conforming loan for the maximum amount of $510,400, and then borrowing $100,000 through a HELOC. Look for a lender willing to do these two loans in one simultaneous transaction at closing.