As a homeowner who has equity
in your home, you can borrow money against this equity. You can either
take out a home equity loan or choose to go for a home equity line of
credit (HELOC). Until a few years back, it made more sense to go in for
a HELOC since interest rates on lines of credit were much lower than
those on home equity loans. But in these days, with the Federal Reserve
rates on a continuous upward spiral, does it still make more financial
sense to hold on to your line of credit, or is it high time you
refinanced? Learn more below.
Understanding Home Equity
Line Of Credit (HELOC)
With a HELOC, you have the
option of borrowing money against the equity in your home, as and when
you need it. For instance, if you have been approved for a line of
credit of say $100,000 you need not borrow all that money at once. You
can borrow it if and when the need arises.
Such loans are always variable
interest loans. The rate of interest that you pay is directly connected
to the bank Prime Rate (the lowest possible lending rates of banks),
which in turn is linked to the Federal Reserve rates. The interest rate
tacked on to lines of credit is typically 0.25% to 1% more than the
Prime Rate. As the Federal rate increase, so does the Prime Rate. And
this means that your interest rate on the HELOC also goes up.
If Federal interest rates are
going down, then it is very advantageous to take a home equity line of
credit as you can enjoy the lowest interest rates possible. However, in
recent years, the Fed rates have only been climbing higher, which makes
HELOCs an increasingly expensive proposition indeed.
Here’s an example to
explain this better:
As of June 2006, the average
interest rate on a $50,000 HELOC is 7.30% (source: bankrate.com);
whereas the rate on a $50,000 home equity loan is 8.10% (both rates are
applicable for people whose FICO credit score is good - between 700 and
As a homeowner, you may be
tempted to think that the HELOC is a better option since you’re getting
a lower rate. However, if Federal rates continue to rise as they have
been (and every indication is that they will), the interest rate on your
HELOC could very well be as high as 9% to 11% in the next few years. If
that happens, you will kick yourself for not taking the home equity loan
which has a fixed rate of 8.10% for the entire duration of the loan.
So if you currently have a
home equity line of credit that does not have a lifetime cap on interest
rates (the maximum amount that rates can rise up to), you may be able to
save a lot of money by refinancing your HELOC and switching to a home
equity loan with a fixed rate.
But when doing so, make sure
you take into consideration all the costs involved in refinancing your
loan. These include closing costs, prepayment penalties, processing
fess for the refinance loan, and appraisal costs. Only after you have
calculated the full cost of refinancing should you make your final
decision. Online refinancing calculators can also help in this regard.
Improving Credit Score
The higher your credit score,
the lower your interest rates on any kind of home equity loan. So order
your FICO score today and take the necessary steps to improve your