Home equity line of credit rates to rise; what should you do?

Mortgage rates may be a mystery; they move up one day and down the next, often befuddling the experts. However, the prime rate, which is the foundation for the interest you are charged on home equity lines of credit, is a bit more transparent.

The Federal Reserve establishes short-term rates — and indirectly the prime rate — in an effort to reach economic targets. When the Fed raises rates, mortgage rates may or may not respond immediately, but the prime rate reacts right away. With one increase in each of the past two Decembers, and with a Fed plan to raise rates three more times this year, it's pretty clear: Your home equity line of credit or HELOC, rate is likely heading higher.

"HELOC loans are generally a function of prime plus something," said Brian Sacks, branch manager of HomeBridge Financial Services in Pikesville, Md. That "something" is a margin, a set markup that varies by lender. For example, if the prime rate is 3.75 percent and a lender adds a margin of two percentage points, your HELOC interest rate would be 5.75 percent.

"Prime will likely go up several times in the coming year," Sacks said. "And certainly, long term, prime is likely to continue to rise."

He said we've likely hit the "low end of the interest rate cycle for quite some time."

If you are going to be staying in the same home for more than the next two to three years, Sacks said you should seriously consider refinancing your home equity line of credit into a fixed-rate loan.

"It's still relatively inexpensive to borrow," said Sean Andrews, senior manager for consumer credit products with KeyBank in Cleveland. He said traditional second-mortgage HELOC borrowers, who have tapped their home equity in a line of credit for home improvements and the like, still have quite a bit of headroom before higher rates start encouraging a change in plan.

Over the past few years, as the prime rate remained in the cellar, Andrews said some borrowers began using HELOCs to refinance their primary, or first-lien, mortgage. First lien means the loan is first in line from a collection standpoint — the highest priority debt placed on a property.

One reason borrowers used a HELOC instead of a typical purchase mortgage: HELOCs often don't have closing costs, he said, though some lenders will require you to pay an annual fee or origination charge. Refinancing into a HELOC with no closing costs has been very attractive to homeowners, particularly those who didn't plan on being in their home long term. Now, as rates start moving higher, Andrews said some customers have already begun moving those first-lien HELOCs to fixed-rate loans.

Dodging higher interest rates doesn't mean you have to give up your home equity line of credit. Many banks let customers take a portion of their variable-rate line and convert it to a fixed-rate loan. "It's taking a chunk of your line and fixing [the rate] so that you can protect yourself from future rate movements," Andrews said. You still have the remaining available line of credit to draw on as you desire, with variable-rate interest charged only when the proceeds are drawn.

While it may be human nature to put such decisions on hold for a while, waiting to consider your options for too long can get you stuck on a ramp of rising interest rates.

Rates could have a "significant and consistent pattern of going up," thus rendering a HELOC unaffordable, Sacks said. Even if your HELOC has a lifetime rate cap that limits how high your interest can rise, it may be a good time to shop options, he said.

"During these moments in time, when rates actually thaw and start moving, customers should unpack their agreements," Andrews said. By dusting off and reviewing those loan docs now, you might prevent the potential impact of procrastination.

If you wait to fix your rate until after interest rates have made a significant move higher — "I want to be honest with you, at that moment, it's too late."