If you have a home-equity line of credit, or thinking about getting one, here is what you need to know to make a smart choice given today’s rate environment.
Home-Equity Lines Of Credit (HELOCS)
These loans are relatively simple to obtain and in exchange for a few hundred dollars of fees you can have access to several thousand dollars of your home-equity to use at your disposal. A home-equity line of credit is the equivalent of a giant credit card secured by your home. Akin to the mechanism of a credit card, where you have a certain line amount you can borrow on. As you spend, your availability of credit reduces, and line becomes available again as you pay down the principle balance. Payments are based on interest only for a period of 10 years and after 10 years; the loan becomes principal and interest for the duration of the remainder of the 30 year term. Closing out a home-equity line of credit is also very attractive as it doesn’t contain a prepayment penalty, but typically, does contain an early closure fee usually in the first few years for a nominal few hundred dollars. Home-equity lines of credit are variable rate loans tied to the prime rate. You’re fully indexed interest rate is what your payment is based off of. The fully indexed rate is your cost of funds.
Prime Rate + Margin = Fully indexed rate
Currently, the prime rate is set at 3.25%. The margin on the loan is the bank’s profit. Prime is always the Fed Funds Rate +3.
Home equity lines of credit in the short term can be a very practical and inexpensive way to access home equity. Compared to taking out a new first mortgage on your home, the fees are substantially less. Generally, expected closing costs for refinancing a first mortgage can run in the three thousand ranges versus home equity line of credit fees in the six hundred dollar ranges. What you give up by taking a home equity line of credit, is comfort of a fixed rate loan. Home equity lines of credit, cost in direct proportion to how strong the economy is. Remember how we were saying a home-equity line of credit is prime +3? Enter The Federal Reserve Bank.
How The Federal Reserve Controls What Pay On Your Mortgage
The Fed Funds Rate is the benchmark rate the Federal Reserve uses to control, kick start or slow down the economy. On December 15, 2015, the Federal Reserve will meet to discuss monetary policy and whether or not they intend to hike rates. It is poised; they will increase the Fed Funds Rate at this meeting. Should this transpire, that will likely put into motion a series of events that will make HELOC payments for many, rise.
Here’s why-the Federal Reserve takes very calculated measures in their decision-making when it comes to economic policy. As such, they need to be careful to keep the economy moving at a healthy pace and doing anything too fast, or too sudden can have lasting negative repercussions far too costly for the stability of the US economy. The Federal Reserve typically, will change the Fed Funds Rate in a series over time.
This is precisely why when you take a home-equity line of credit for the cash you need, you are accessing your cash in the form of debt servicing, at the mercy of whatever the Federal Reserve does or does not do with the Fed Funds Rate. When the Fed hikes rate a .25% the Prime Rate will also follow suit, and you can expect your payment the following month to rise, not rise dramatically, but rise enough to cause worry especially for homeowners who scour over every line item of their monthly bills.
Ultimately, whether it makes sense to choose a HELOC or to restructure your current first mortgage in exchange for accessing your home-equity is entirely upon you. Make no mistake, the premium you pay in restructuring your first mortgage provides a guarantee of your future payments, as well as manageable vehicle you can plan your income and savings around.
If you plan to tap your home equity via an equity line of credit, and you do not know definitively when the balance will be paid off
Then cash out refinancing your first may be a more prudent direction mindful of the fact fixed rate first mortgages are still just sub 4%.
If you know unequivocally, you will be able to pay off your home equity line of credit balance within the first 48 months
Then a home-equity line of credit could be a much more cost favorable financing vehicle to access the equity in your home. This is because the shorter time frame you have your home equity line of credit, the less susceptible you are to changes the Federal Reserve will inevitably make in your cost of funds.
Can’t decide which way to go? Concerned about your equity line of credit payments rising? Start by getting a free refinance quote online today!