Once you know what a HELOC — a home-equity line of credit — is and how you intend to use it, one key question remains: How do I get the best deal on a HELOC?
The best deals are going to go to those with excellent credit and plenty of equity. Borrowers who are strong in only one of those two areas have some work to do.
Until you answer the question about who offers the best deal on a HELOC, you shouldn’t sign any offer. After all, you’re putting your home on the line for this loan.
Getting the best rate on a HELOC
It all comes down to this: To get the best rate on a HELOC — more to the point, to get the best deal on a HELOC — you have to shop. Big national banks. Community banks. Credit unions. Online lenders. Fill your basket with options.
Because HELOCs have lots of moving parts — variable interest rates, introductory/teaser rates, closing costs, fees, possible balloon payments — it’s wise to have weighed the apples-to-apples offerings from a variety of lenders before you sign on.
Next, use online tools to ascertain your home’s equity — that is, the difference between your mortgage balance and your home’s market value. If your home is appraised at $150,000 and you owe $100,000 on it, you have $50,000 in home equity.
Now you’re ready. You want the best deal on a HELOC? Be patient. Do your homework. And shop. You’ll thank yourself later.
HELOCs are more complicated than a first mortgage, which traditionally involves a fixed interest rate and a set payback period, usually 15 or 30 years.
HELOCs also should not be confused with home-equity loans, in which the lender hands you a lump sum, again with a fixed interest rate and payback schedule that normally runs 10-15 years.
Instead, a HELOC is an adjustable-rate mortgage with two components: a set, or fixed, rate — the margin — plus a fluctuating rate — the index. Your payment each month will reflect your lender’s application of both rates to your loan balance.
Getting the best available rate on both is critical. But so are upfront costs, closing costs, annual fees (if any), and an assortment of other variables, from introductory teaser rates to inactivity fees to balloon payments. The wrong combination of any of these can turn what looks like a great deal into a disaster.
So, to reiterate, shop around. No, really. Shop hard.
Even if you like who’s holding your first mortgage. Even if you have an excellent payment record with them. Even if their records on you suggest the application process will be a breeze.
Know why milk is pricier at the 7-Eleven than at the supermarket? Because convenience often has a cost.
Maybe your mortgage lender is your best bet. You won’t know that if you don’t give others a shot. So, again, shop. As you do, be certain to compare apples to apples: margin, index, closing costs, add-on fees and so on.
Here are some things to watch out for:
- Low introductory, or teaser, rates that don’t last. Make sure you know how long the low starting rate will last, and have an idea of what the APR — annual percentage rate — is likely to be when the interest rate honeymoon ends.
- Rate markups. Sure, HELOC rates are based on the prime rate. But for your credit line, it’s going to be the prime rate plus, and that plus can make all the difference.
- Rate caps. Find out if the lender has a program that puts a limit on your rate, and how you can qualify.
- How long is the draw period? The typical draw period – time you can withdraw money from your line of credit – is 5-10 years.
- Burrow in to learn about hidden fees. Do you have to withdraw a certain amount in a certain time frame, like the first year? Are there inactivity penalties?
- Know whether the lender requires a balloon payment. Balloons at the end of a loan often are used to lower monthly payments; know what you’re getting into.
- Beware prepayment penalties. Suppose you’re suddenly able to pay off your HELOC in a big lump sum. Know before you sign up whether the lender will ding you for getting out early.
Understanding the HELOC introductory rate
To get your HELOC business, lenders often include a low, low, seriously low introductory rate — oftentimes at or below prime. Not that there’s anything wrong with that.
In fact, the introductory rates crush most credit card and personal loan rates. The teaser rates usually last 6-12 months, but some stretch out as long as two years, and can be staggeringly attractive for short-term debt.
Be aware, however, about the rate bump that awaits at the end of the honeymoon. Your rate, and monthly payment, could easily double. So be wary about getting yourself into a payment scenario that squeezes your budget, putting your home at risk.
Predicting future rates for a variable HELOC
Where will interest rates be in a year or two? All the smart folks on the business channels say they’ll be higher.
The Federal Reserve seems to have at least three rate hikes built into its 2018 schedule, and even though it’s anticipated they’ll be small — a quarter point each time — that means the overnight rate (the rate banks charge each other) will be nearly a point higher in 2019 than it is now.
Then there’s the unwinding of the Fed’s balance sheet — the unprecedented debt load the central bank took on during the financial crisis of the previous decade — and that’s supposed to put upward pressure on interest rates, too.
In short, consumers with variable-rate loans need to keep a weather eye out. Talk this over with every potential HELOC lender; see what together you can do to hedge your risk.
Meanwhile, there’s a handy calculator nearby that can help you predict what your payments will look like under assorted scenarios. Plug in the amount you intend to borrow and assign potential interest rates. Could you sleep if your rate zoomed to eight, nine, even 10%?
If not, but your need for a HELOC is keen, have a plan in place to pay it down sooner rather than later.
It’s also a good idea to understand precisely what your loan agreement calls for. What does the contract language say about the margin and the index? How is the margin set? What about the index?
If it’s all too much, consider a straight home-equity loan, in which you’ll get an immediate lump sum loan at a set interest rate and a date-certain payoff. Or consider a full first-mortgage refinance that includes pulling cash out of your house.
Refinancing is a particularly good idea if you were counting on your HELOC payments being tax deductible. Interest payments on first mortgages up to $750,000 remain deductible.
By comparison, HELOC interest payments became tricky. Before December, they were deductible, period. Now they’re deductible if (a) the loan was used to make improvements on your home and (b) the total of your mortgages does not exceed $750,000.
If, instead, you use a HELOC as a debt consolidation tool, or to pay off student loans, or to fund that once-in-a-lifetime family vacation, Washington is not going to help subsidize your choice.
So, as noted earlier, do your homework. Study. Shop hard. Compare like to like. You’ll be ready to make your best deal.