By AnnaMaria Andriotis
As the Federal Reserve prepares to raise interest rates, banks
are promoting home-equity lines of credit with a temporary fixed
rate.
The feature can be useful for borrowers who value predictability
and plan to pay back the money before the fixed-rate period ends.
But just as with traditional versions of the product that carry
variable rates throughout, borrowers still could see their monthly
costs eventually increase.
Home-equity lines of credit, known as Helocs, let borrowers use
their homes as collateral to get cash that they can spend on
repairs or renovations or on unrelated expenses, such as college
tuition and vacations. Borrowers incur interest charges only on the
amount they withdraw.
On typical Helocs, the rates can fluctuate as often as monthly.
Now, more lenders are offering Helocs with a fixed rate that often
lasts from 12 months to many years. Generally, the longer the
fixed-rate period, the higher the interest rate in that period.
SunTrust Banks, for example, started offering a Heloc in
December that comes with an initial interest rate that is fixed at
2.99% until January 2017 for funds borrowers withdraw immediately.
In September, Regions Financial introduced a 1.99% fixed interest
rate for the first 12 months a borrower has a Heloc.
Nearly 9% of Helocs offered in January had a fixed introductory
rate, up from 7% a year ago and 1% in January 2010, according to
survey data from home-loan information website HSH.com.
The offers are aimed at getting homeowners to use their Helocs
as soon as they get them, since the clock on the fixed-rate period
usually starts ticking once the borrower signs up, says Guy Cecala,
chief executive and publisher of Inside Mortgage Finance, a trade
publication. Experts say banks hope to boost lending amid tepid
demand for traditional mortgages.
Some lenders are even allowing borrowers to pick when the
fixed-rate period begins. In February, EverBank Financial started
allowing borrowers to shift to a fixed interest rate on an existing
Heloc for up to 10 years.
Consumers are increasingly inquiring about Helocs with temporary
fixed interest rates because they are concerned that interest rates
could soon rise, according to Kelly Kockos, home-equity product
manager at Wells Fargo.
Their concern is that, if rates do rise, they could face higher
monthly payments just as a kitchen renovation or other costly
project gets under way, she says.
But Helocs also carry many of the same risks as adjustable-rate
mortgages, which tend to have a fixed interest rate for a limited
period. Such mortgages were popular with home buyers before the
financial crisis, and their widespread use contributed to the spike
in foreclosures during the housing bust as borrowers were unable to
keep up with monthly payments when interest rates rose.
In fact, interest rates on Helocs can spike even higher. Most
adjustable-rate mortgages cap the increase in the interest rate at
five or six percentage points over the life of the loan. By
contrast, the interest rate on most Helocs can rise as high as 18%,
far above the average rate of 5.13% as of January, according to
HSH.com, though that would happen only if interest rates in general
rose far above current levels.
That kind of increase could make it difficult for borrowers who
aren't wealthy to keep up with payments, though the outstanding
balances tend to be much smaller than on adjustable-rate mortgages.
Falling behind on Heloc payments also could lead to
foreclosure.
Moreover, many Helocs allow for interest-only payments during
the first 10 years. For the remaining 20 years, principal and
interest is due monthly. That can add to the shock of a rising
interest rate.
To protect yourself against rising monthly payments, find out
how much the interest rate on a Heloc could change after a
fixed-rate period ends. The interest rate on Helocs from Wells
Fargo, for example, can rise by a maximum of seven percentage
points over the life of the line of credit.
In addition, note that most Heloc rates are pegged to the prime
rate, which typically moves in tandem with short-term interest
rates set by the Fed. So find out how far above prime your interest
rate will be. Regions, for example, charges prime plus one to six
percentage points on its Helocs.
Homeowners borrowing a smaller share of their home value and who
have a higher credit score are more likely to end up with a smaller
margin between the prime rate and the rate they pay.
If you are worried about spiking interest rates, consider taking
out a home-equity loan, which typically carries a fixed rate for
the life of the loan.
With home-equity loans, borrowers withdraw the entire amount
they need in one lump sum and incur interest charges on that sum
right away. Such loans can be a better choice for borrowers who
know they will need only a set amount of cash right away.
The interest rate on home-equity loans, though, tends to be
higher. The average rate on such a loan was 6.25% in January,
compared with 5.13% on Helocs, according to HSH.com.
Write to AnnaMaria Andriotis at AnnaMaria.Andriotis@wsj.com
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