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Home equity options get complicated as rates rise
We have written extensively about how useful it is to have a home equity line of credit. Unlike a traditional home equity loan, which has a fixed interest rate, a fixed amount borrowed and a fixed repayment schedule, a line of credit offers much greater flexibility. Once approved for a credit line, a homeowner may borrow a little at a time of all of it at once. The interest rates are adjustable, and the payment schedule is flexible, much like paying off a credit card balance. If you don’t want to take out any money at all, you can do that, too. By taking out the money only when you need it, a line of credit makes a great rainy day fund.
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With interest rates rising, a line of credit doesn’t look so good. A line taken out three years ago now has monthly payments that are twice what they were. Those rates and payments are likely to keep rising in the future. What should you do if you are in this situation?
You have several options:
- Keep it - If you are only keeping the credit line for emergency use and don’t have a balance, you may wish to simply keep it and not worry about it. If you have a small balance, you might just want to pay it down and put the line aside for a while. Or you may just accept that rates are higher and consider that a cost of convenience. A line of credit is still a very useful financial tool, even if it costs more than it did a few years ago.
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- Convert to a home equity loan - You could contact your lender and see about converting your line of credit to a fixed-rate home equity loan. You will lose the flexibility, but you will have the peace of mind that comes from knowing that you have a fixed payment each month until your balance is paid off.
- Get a “convertible” credit line - Some lenders offer a credit line that lets you convert all or part of your balance to a fixed-rate loan. The terms vary by lender, but you should inquire about it.
- Refinance the whole house - It is still possible to simply refinance the entire house with a cash-out refinancing. With such a loan, you refinance the home for the mortgage value plus the amount that you owe on the line of credit. Once you have done that, you can pay off the credit line with the extra cash. This may be a good time to do this if your home is financed with an adjustable rate mortgage and you would like to convert it to a fixed rate loan. You could, in effect, kill two birds with one stone by refinancing both your first and second mortgages at once.
Each borrower will have his or her own special needs, so there is no single solution that works for everyone. If you have doubts about what you should or shouldn’t do with your line of credit, consult with your lender.
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