Six HELOC Strategies for a Rising Interest
Rate Market
Most home equity line of credit
(HELOC) loans are indexed to the bank prime loan rate. This means that
when the prime rate changes, the rate on your HELOC loan will change too,
typically within a few weeks time.
When prime increases 100 basis
points (one full percent) the typical home equity line of credit borrower
with a $30,000 balance, pays an additional $300 in yearly interest costs.
If you make monthly payments according to a fixed schedule, the rise in
rates also means less of each payment dollar goes towards reducing principal.
In other words, it will take longer to pay off the loan balance. Interest
rates seem likely to continue rising (at least in the short run), so it
is worthwhile to look at some strategies available to HELOC borrowers to
help control the damage to their wallet:
1. 0% Balance Transfer
Offers - If you have good credit and are attentive to details, transferring
some or all of your HELOC debt to a 0% credit card can be a viable strategy.
You can ride the 0% offer until it expires knowing that you can always
payoff the balance with a HELOC check (effectively transferring the balance
back to the HELOC). A few downsides of this strategy are:
a) minimum monthly payments will be 2% - 3% of the balance which may be
higher than the minimum payment for an interest-only HELOC;
b) you must be on top of all the details related to the 0% offer. For example,
Discover offers a "0% for life balance transfer, but you must be
certain to make a minimum number of purchases each billing cycle to keep
the 0% rate. Trip up and your rate can immediately skyrocket to double-digits;
and,
c) most offers have a balance transfer fee associated with them.
Typically, the fee is 3% - 5% of the transferred balance with a maximum
(e.g. $50.00). Be sure you know exactly what the transfer fee is
and that the interest savings you expect to realize will easily offset
it. It is worthwhile calling the credit card company to discuss their
balance transfer fee. Account reps often have discretion to waive
the fee if they think doing so will close the deal.
There's no free lunch with
this strategy, but if you are willing to put in the effort, you can realize
significant interest savings.
2. You can also refinance or
roll your HELOC into a fixed rate home equity loan or your first mortage
. This will protect you from further rate increases - but can backfire
if rates fall again. In the current market, longer-term fixed rate
loans have not risen in step with increases in the prime rate. This
makes this an attractive option for some.
A key factor if you are considering
this move is to carefully analyze the up front closing costs of the refinancing
transaction and determine whether you will remain in the home long enough
to recoup these costs through interest savings.
3. Perhaps the simplest, most
effective strategy is to inventory your cash assets and pay down the debt.
If you have cash sitting in CD s, money market accounts or other investments
earning less than the rate on your HELOC, consider using that cash to pay
down the interest-accruing balance on your HELOC. You can still get
the funds out in an emergency by simply writing a HELOC check.
Be sure you consider the effective
after tax rate on your HELOC when comparing rates.
4. Review the terms of your
HELOC with your banker. Things you should be familiar with include the
specific index and margin used (e.g. prime rate -.25%), frequency of rate
changes - monthly, quarterly, etc. (less frequent is better when rates
are rising), and the lifetime cap on your rate.
If you have had the same HELOC
for several years, you might find you a have a relatively low cap. Some
HELOCs originated 4-5 years ago have lifetime caps as low as 7%. Also,
find out if your HELOC permits a conversion to a fixed rate home equity
loan with little or no closing costs.
5. Ask your lender if there
are any rate discounts available. For example, some credit unions offer
to discount your rate by a quarter percent (0.25%) if you have monthly
payments automatically deducted from a checking account. Other discounts
may be available if you have a significant service relationship (e.g. checking,
savings, CD, business accounts, etc.) with the bank.
6. Look for a better HELOC
deal. The market remains very competitive with many lenders offering sub
prime rates with low or zero closing costs. Shop the internet and shop
your local lenders to find the best HELOC deal. And don t be shy
about letting your current lender know that you are shopping - if you have
a banking relationship they value, you may find them very willing to give
you special consideration.
Rising interest rates are a
cyclical fact of financial life. The good news is that even with
recent increases, HELOC rates are still at historically low levels.
Furthermore, the tax-deductibility of interest keeps the HELOC loan the
most cost-effective method of borrowing for the savvy consumer.
Author-Bio: Tim Paul is a financial
management executive with more than 25 years experience. His focus
is on personal finance issues including HELOC Loans and 529 College Savings
Plans. Visit his websites at http://www.sagetips.com
and http://www.529rewards.com.
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