If you have a home equity line of credit (HELOC), you may have the option to switch from a floating rate to a fixed rate. And in a year when rates hit rock bottom, all you can do is go up. But there are a couple of things you need to be aware of.
First, make sure you understand exactly what is meant by a fixed rate HELOC.
What is a fixed price HELOC?
HELOCs are inherently floating rate products, which means that your interest rate will fluctuate based on the reference rate. HELOCs generally have a term of 30 years with a 10-year drawing period and a 20-year repayment period.
Worst-case scenario, “If the policy rate goes up sharply, which can happen, people may not be able to pay the nominal payments based on the higher floating rate, and then you could end up in the situation of being foreclosed,” says Mike Caligiuri, founder of Caligiuri Financial in Columbus, Ohio.
A fixed rate HELOC can prevent this by locking some or all of the remaining balance on your variable rate HELOC at a specific rate. Essentially, this converts your HELOC into a fixed rate loan after your draw is up, which can be helpful in an environment where interest rates are rising.
This can take more steps than flipping a switch on your current HELOC to freeze it at the current rate. This could mean closing your HELOC and converting the remaining balance into a fixed rate home loan. For all intents and purposes, a fixed rate HELOC works just like a home equity loan.
“Generally speaking, these are two separate loans. So it’s usually not that easy to say, ‘I want to convert,’ ”says Yves-Marc Courtines, CPA with Boundless Advice in California.
When should you get a HELOC at a fixed price?
When interest rates go up, setting a lower interest rate guarantees you won’t have to pay a higher APY later.
“For example, some lenders offer borrowers the option to set the interest rate on their outstanding balance so that they won’t be exposed to rising interest rates after they accumulate a balance,” said Greg McBride, chief financial analyst at Bankrate.
This can be useful if you think interest rates are about to go up and you want to avoid paying more interest. Remember that you typically have a 10 year draw period to access these funds.
“If your home equity line of credit has a large balance, you may want to convert to a fixed rate loan to protect yourself from interest rate risk if the interest rate goes up,” says Caligiuri. “If interest rates go up, that’s the bank’s problem.”
There is also often a small fee associated with setting your HELOC course (usually $ 50 to $ 100). But if you protect yourself from rising interest rates, this fee can definitely be worth it. Consider the pricing environment and the amount of the fee before making a decision.
Interest rates are currently low. This makes HELOCs harder to get hold of, as credit is tighter and “interest rates are low and likely not to rise in a few years,” says McBride.
Once you decide to set your HELOC rate, the first step is to speak to your lender. If properly planned, repairing your HELOC can help save you money on interest over the course of the loan.