With a home equity line of credit (HELOC), homeowners can borrow from their home’s equity whenever they need to, usually for expenditures like making home improvements, debt consolidation, education, or major medical bills. The home serves as collateral for a loan, and, like a credit card, a HELOC needs to be paid back.
HELOCs typically have variable rates, but it is possible to get a fixed-rate HELOC.
While HELOCs usually come with variable rates that fluctuate based on market conditions, you can convert some or all of your HELOC to a fixed rate. If interest rates are rising, a fixed-rate HELOC could save you money by locking into the current interest rate while still giving you an open line of credit. There are also hybrid HELOCs, where you can convert all or part of your HELOC to a fixed rate.
Both fixed- and variable-rate HELOCs come with a draw period and a repayment period. The draw period is typically 10 years. During this time, you pay only the interest each month on the money you borrow. When the draw period ends, you pay back the principal and interest during the repayment period, which typically lasts 20 years.
With a variable rate, the interest rate you pay changes depending on market conditions. If interest rates go down, a variable-rate loan is good for you, since you’ll pay less in interest each month. But if rates rise, you’ll pay more. Interest rates are based on index and margin.
People who want a fixed interest rate typically take out a home equity loan, which is similar to a HELOC in that you’re borrowing money using your home as collateral.
A home equity loan is one lump sum amount that comes with a fixed rate, however, while a HELOC gives you a revolving line of credit, typically with a variable rate. A fixed-rate HELOC combines the two products by offering borrowers a fixed rate on a revolving credit line.
Because a HELOC is generally a variable-rate product and a home equity loan is usually a fixed-rate product, you might wonder why you wouldn’t just get a home equity loan if the type of interest rate you get matters most. One reason is that you might not know how much money you’ll need.
| For example: Let’s say you’re approved for a $75,000 second loan on your house, either through a home equity line of credit or a home equity loan. If you take the home equity loan, you’ll be borrowing $75,000, all of which you’ll need to pay back — plus interest. But you might only need $50,000. With a home equity line of credit, you borrow and pay back only what you use. You have more options regarding how much you borrow with a HELOC. |
Here are a few advantages to consider:
Fixed-rate HELOCs come with a few drawbacks as well:
A fixed-rate HELOC might make sense when you plan to borrow a large amount of money during a time of rising interest rates. Having a fixed-rate HELOC means your interest rate will stay the same on the money you borrow.
Here’s an example of just how much interest rates can impact you.
Let’s say you have an outstanding balance of $20,000 at a 7.5% interest rate on a 20-year loan. If your minimum monthly payment is $125, you will pay a total of $30,000 for that loan.
Compare that with the same balance, but at a 6.5% interest rate. Your minimum monthly payment would go down to about $108 per month, and you’d pay a total of about $26,000 for the loan. The higher the interest rate, the more your line of credit will cost you. And the greater your loan amount, the more you’re impacted by the interest rate you’re charged.
Remember that with any type of financial product that uses your home as collateral, as both fixed- and variable-rate HELOCs do, you could lose your home if you stop making payments on a HELOC.
Related: Learn more about refinancing your mortgage on Credible.com