One key thing to ask if you’re considering a HELOC – which most people don’t

What is a HELOC and how does it work?

But first, you need to understand the basics of a HELOC. A HELOC is a line of credit, borrowed against the equity in one’s home, where the home is used as collateral for the debt. They typically have terms of 30 years, including a 10-year drawdown period and 20-year redemption period. The drawdown period is when the borrower is allowed to withdraw from their line of credit, and during this period, which is usually 10 years, the borrower is usually only required to pay interest on the loan; once the drawdown period is over, the borrower can no longer use the line of credit and must repay the loan balance, including principal and interest. This repayment period usually lasts 20 years.

HELOCs are generally variable rate products, which means that their interest rates fluctuate with the prime rate. But not all HELOCs are tied to a variable-rate structure, and it may be important to think about that in this low-rate environment (see the latest HELOC rates you may be eligible for here).

A fixed rate option on a HELOC

When researching a HELOC, Greg McBride, chief financial analyst at Bankrate, says it’s important to ask lenders if they allow the ability to fix the interest rate on an outstanding balance. This allows a borrower to lock in a portion of the outstanding balance at a fixed rate or convert a HELOC to a fixed rate after the drawdown period. “This can be great if you’re looking to refinance an existing variable rate HELOC or if you plan to borrow all the money fairly quickly and want to lock in your interest rate,” McBride says.

A fixed rate also means the monthly payment on your existing balance won’t change, which can be valuable from a budgeting perspective, as it provides greater certainty about the cost of additional borrowing during the drawdown period. “Especially with interest rates set to rise several times over the next two to three years, a variable rate can present a lot of uncertainty as to what it will cost and what your payments will look like in the near future. months and years to come,” McBride said.

If you purchase a variable rate HELOC and want to convert it to a fixed rate due to a home renovation, family emergency, or to consolidate debt, you can either open a new HELOC or refinance your old HELOC by paying the balance of the old loan and using the funds from the new fixed rate loan in which your drawdown period would be reset.

Because interest rates are likely to rise over the next two years according to economists and could rise faster than we’ve seen in recent history, fixed-rate HELOCs are particularly attractive. right now, say the pros (see the latest HELOC rates you might qualify for here). “But as the saying goes, ‘there’s no free lunch,’ so a fixed rate HELOC may incur higher fees or penalties for closing early, or having a higher rate to start with, because the lender assumes the risk of higher rates. in the future,” says McBride.

Marguerita Cheng, Certified Financial Planner and CEO of Blue Ocean Global Wealth, says the biggest benefit of a fixed-rate HELOC is the peace of mind of an interest rate that won’t fluctuate. “In the short term, it may be a higher rate than the variable rate but [you should still] chase it if you want stability and predictability,” Cheng says. This, she says, is because you don’t want to have a large HELOC balance with a variable, fluctuating payout.

Fixed-rate HELOCs can also be a good option for homeowners looking to pay for home improvements rather than taking a chance on buying a new home in today’s competitive housing market.

So should you pursue a HELOC with a fixed rate or not? Basically, if the prospect of a variable rate and the likelihood of higher interest rates means higher monthly payments that would strain your budget, it’s wise to look for a fixed rate that can alleviate that uncertainty. “The rate may be higher than if you took out a variable rate, but it could still pay off if interest rates rise significantly over the next two years,” McBride says.

Is a home equity loan or a HELOC the right choice for you?

Home equity loans have fixed payments and interest rates and a lump sum of funds paid up front, while variable HELOCs offer revolving lines of credit, fluctuating payments and a limited time to withdraw the loan. loan money (known as the drawdown period). If you know exactly how much money you need for a specific reason, a home equity loan might make more sense than a HELOC, which offers the flexibility to borrow for a longer period.

Advantages and disadvantages of a HELOC, and what to use a HELOC for

Although a viable option for many, applying for a HELOC does not come cheap. Initial costs can include application fees, a title search, and an appraisal that can cost hundreds of dollars. Therefore, if you are looking for a small loan, there may be a better solution. And if you don’t pay off your HELOC, you could lose your home.

The pros say some of the best uses for a HELOC include home improvement projects, to pay medical bills, or to consolidate high-interest debt (see the latest HELOC rates you may qualify for here). But experts advise avoiding a HELOC for discretionary spending.