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Many people borrow against their home equity to make home improvements, pay for medical bills, or cover school fees. They often do this by taking out a second mortgage – a home equity loan or home equity line of credit (HELOC). These loans allow you to borrow large sums at low rates, provided you are ready to give your home as collateral.
Traditionally, choosing between these loans has meant choosing between a fixed interest rate with a home equity loan or a variable interest rate with a HELOC. But with a fixed rate HELOC, you get the best of both worlds.
Here’s what you need to know about fixed rate HELOCs:
What is a fixed rate HELOC?
A fixed rate HELOC is just that: a home equity line of credit with an interest rate that doesn’t change.
Normally, HELOCs carry an adjustable interest rate. However, adjustable interest rates have drawbacks that many borrowers find unattractive, one of the main ones being fluctuating monthly payments.
People can be reluctant to take out a loan when they don’t know how much it will cost them in the long run or what they will owe from month to month. And lenders can struggle to collect what borrowers owe when a rate hike makes loan payments unaffordable.
Point: Fixed rate HELOCs are not offered by all lenders. Ask your lender if they offer this option before purchasing an adjustable rate HELOC.
Fixed rate HELOCs are a cross between HELOCs and home equity loans
HELOCs and home equity loans are both considered second mortgages, but there are distinct differences between the two:
- Home equity loan: A home equity loan allows you to borrow a lump sum against the equity in your home and pay it back over a number of years at a fixed interest rate. For example, you could borrow $ 30,000 at 5% for 30 years, like a first mortgage. Your monthly payment will never change.
- HELOC: A HELOC works like a credit card. You can borrow as much or as little of your line of credit as you want during the first five to 10 years of the loan (also called a “drawdown periodâ€). It is followed by a repayment period of 10 to 20 years.
The initial interest rate on a HELOC is usually lower than the rate on a home equity loan, but the rate can adjust as often as once a month as broad market rates change.
This is where fixed rate HELOCs come in handy. A fixed rate HELOC is like a cross between a home equity loan and a regular HELOC. It gives you the ability to draw on a line of credit at your convenience as well as the ability to lock in your rate on the amounts you borrow, reducing the uncertainty of what you will pay per month.
You won’t find a fixed rate HELOC at Credible, but for another way to leverage your home equity, consider refinancing with cash. Credible can help you check the refinancing rates of all of our partner lenders. Checking rates with us is safe and easy, and it won’t affect your credit score.
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Advantages and Disadvantages of a Fixed Rate HELOC
If you are considering a fixed rate HELOC, you should understand the pros and cons before you apply.
Benefits
- Regular monthly payments: When you lock in your interest rate, you know what your payment will be each month. It’s easier to budget.
- Borrow as needed: Unlike a home equity loan, you don’t need to know up front how much you want to borrow. You will borrow as much as you need and only pay interest on that amount. You could save money on interest this way, especially if, for example, your home improvement project ends up costing less than you expected.
- Same diplomas: The second mortgage qualifications related to income, debt, home equity, and credit score are more or less the same whether you want a fixed or variable rate HELOC (or a home equity loan). ). The lender you choose is more important than the loan product you choose.
The inconvenients
- Don’t miss the rate cuts: If you lock in your rate and then the rates drop, you won’t automatically benefit from the lower rate like you would with a variable interest rate.
- More decisions to make: A fixed rate HELOC is basically still a HELOC. By default, you will benefit from a variable interest rate. You have to choose how much of your credit to lock your rate on and when to block it.
- Limits of rate foreclosure: Your lender may limit you to locking in your rate on only a portion of the money you borrow. They may require you to borrow a minimum amount to lock in your rate, and you may pay additional fees.
Alternatives to a fixed rate HELOC
A fixed rate HELOC is just one of many options for borrowing against the equity in your home. Consider these three alternatives to fixed rate HELOCs to decide what is best for your situation.
HELOC variable rate
Better if: Your HELOC is just for emergencies.
If you don’t intend to actually use your HELOC but want to know that the money is available to borrow in an emergency, then it makes sense to stick with a traditional HELOC with variable rate.
This way, you won’t be paying interest on money you may never use, like you would with a home equity loan. And you may be able to take advantage of a lower interest rate later.
Point: Be aware that lenders can freeze or reduce your line of credit if your credit rating drops, your home’s value drops, or the economy worsens.
Home equity loan
Better if: You know how much you want to borrow and how long you need to pay it back.
A home equity loan is very similar to a fixed rate mortgage. If you know you need $ 100,000 to build an addition to your home, replace the roof, and paint the exterior – and that paying off the money over 20 years will be affordable – then a home equity loan may be a good idea. choice.
However, if the rates go down, you will have to refinance your home equity loan to get a lower rate.
To verify: Second mortgage vs home equity loan: understanding the difference
Refinancing of collection
Better if: You want to borrow a lump sum and get a lower rate on your first mortgage.
Maybe your first mortgage rate is 5% and you could get a 3.5% rate by refinancing, but you also want a lump sum to pay off your high interest debt.
Refinancing with cash might be your most profitable option in this case. However, the closing costs can be considerably higher compared to a second mortgage.
Keep reading: Home equity loan vs personal loan: which one is right for you?
