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Consumers considering a second mortgage, whether for debt consolidation or home-improvement projects, face a decision between an open-ended home equity line of credit (HELOC) and the fixed-rate home equity loan.
A few months ago, in a rising interest-rate environment, the fixed-rate loan was the slam-dunk winner for consumers. Now, the choice is not so clear-cut.
Rates have remained stable throughout the summer after a steady 12-month run-up following rate increases caused by the Federal Reserve Board. The stability in home equity rates is attributable to no rate increases since May. Home equities move in response to Fed rate hikes, unlike mortgages, which move in anticipation of Fed hikes.
Shop around
Because the Fed is not expected to boost rates further in the coming weeks, nothing is pushing these rates higher. So don't feel rushed -- this is a good time to shop around.
As you shop, you'll notice that HELOCs often carry low introductory rates that switch to a variable rate later. If you took one of them out six months ago, we're sorry. You're now getting walloped by markedly higher rates.
Home equity lines are most commonly benchmarked to the prime rate, the federal funds rate or jumbo CD yields. When these rates spike upward, as they have this year, so do the home equity rates after the introductory period expires.
Consumers who took the attractive three-month introductory rate at 6 percent on a HELOC in March, with prime plus 1 percent thereafter, found themselves paying 10.50 percent instead of 9.75 percent after expiration.
The wise move at the time was to take a fixed-rate home equity loan instead, to avoid being squeezed by rising rates.
Decisions, decisions
The choice isn't so clear-cut now. There's the chance that the Fed may slash rates in the next six months, so variable-rate HELOCs are a viable alternative once again. As interest rates and the benchmark indexes decline, the post-introductory rate may also decline, assuming the lender's margin remains intact.
For example, consider the average fixed-rate loan at 10.25 percent vs. a variable-rate HELOC priced at prime plus 1 percent margin. Currently, prime plus 1 percent equates to 10.50 percent, but if the prime rate falls by 50 basis points over the next six months, then the rate is 10 percent. Factor in the savings that many lenders offer through low introductory rate periods on HELOCs and the decision becomes more obvious.
There is no one-size-fits-all loan. Individual considerations such as the balance of the loan and the period of repayment are sure to come into play. Keep in mind that interest rates go through cycles -- they do not go up, or down, forever.
For consumers currently considering a home equity product, before locking in a fixed-rate loan, be sure not to overlook better options on a HELOC where the post-introductory rate may decline over the next six to 12 months.
The timeless advice is to always comparison shop. Both the fixed-rate loans and the variable-rate lines are widely available; both vary widely in price by institution. Some lenders may only offer one or the other, plenty offer both. Some of these lenders may offer both at the same rate and some will price one product better than the other.
Finally, in addition to looking at the rates, knowing the terms and fees is crucial to making the best decision.
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