Due to recent cuts, the prime rate is very low right now (5.25%). That means most HELOC borrowers are paying less in interest every month. Some financial advisers have suggested that the rate cuts make today a smart time to take out an adjustable rate home equity line. However, not everyone agrees.

While HELOC rates are currently low, some analysts believe that inflation will eventually lead to higher rates in the future. Should this scenario hold true, borrowers with fixed interest rates will have the advantage.

Consider this example from TheStreet.com:

“Rising rates aren’t bad news for all borrowers. If you hold a long-term fixed rate loan, higher rates won’t affect your payments. What’s more, rising inflation will reduce the value of your monthly payments. For example, an inflation rate of 4% reduces the value of a $2,000 monthly payment to $1,643 in today’s dollars over five years.

By contrast, borrowers with variable-rate debt suffer from rising rates. Say that you qualified for a 30-year 3/1-year ARM (an adjustable rate mortgage whose rate is fixed for three years and then adjusts annually) at a rate of 5.5%. Your payments for the first three years would be $1,135 a month on a $200,000 mortgage.

A one percentage point increase in rates will boost your payments to $1,255 — and a three percentage point increase in rates could leave you with a monthly mortgage payment of $1509. That’s an extra $374 you’ll need to come up with each month, assuming rates don’t climb even further.”

HELOC borrowers may have the short term advantage, while those with fixed-rate home equity loans win out in the end. If you’re a HELOC customer worried about the possibility of inflation-related rate increases, you could refinance to a traditional home equity loan.

Alternatively, you may want to use your low-interest HELOC now and convert the withdrawn amount to a fixed rate when the market begins to shift. Not all HELOC lenders offer the conversion feature, however, and it can be extremely difficult to accurately time rate increases.
See also:

Home Equity Loan vs. Home Equity Line of Credit

Tags | Heloc, HELOC risks, refinance