If you’re one of the lucky few in this situation, don’t be too hasty to switch to a lower rate. Paying off your original home loan with a HELOC can be quite risky.

Jack Guttentag for Inman News Service explains:

“A reader with a HELOC who wrote me recently had a margin of minus 0.75 percent, which made her rate 2.5 percent. Her first mortgage had a rate of 6.5 percent, and her HELOC lender offered to increase her line by enough to pay off the first mortgage. The prospect of converting a 6.5 percent loan into a 2.5 percent loan was indeed enticing.

Nonetheless, I advised against it. The reason is that she did not expect to pay off the loan for 15 years, and over that long a period, the risk from the HELOC is too high.

The prime rate is extremely volatile. In 1980, it jumped from 13.5 percent to 21.5 percent in two months! This was an unusual episode, to be sure, but unusual episodes are becoming commonplace these days.”

By shortening your repayment period and converting a fixed rate to an adjustable rate, you’re opening yourself to the some serious potential problems.

See Also:

Answers to Common HELOC Questions

Is a HELOC Right for You?

The New York Times reports:

“The Fed said in a statement that, because of weakening economic activity, it had cut the Federal funds target rate by half a percentage point, to 1.5 percent. It also cut its discount rate by the same amount. The vote was unanimous…

Federal Reserve officials said Wednesday’s action was the first time ever that the Fed had coordinated a reduction in interest rates with other central banks, though the United States has periodically joined with other countries to intervene in currency markets to stabilize foreign exchange rates.”

Major banks including National City, Wells Fargo, and Wachovia followed suit by lowering their prime lending rates to 4.5%. The prime rate is the rate that is given to the most credit worthy borrowers.

For more information on how this may affect you see: Will Federal Rate Cuts Affect Your HELOC APR?

The Associated Press reports:

“Many believe the Fed will ratchet down a key lending rate to banks — now at 2 percent. In turn, the prime lending rate — now at 5 percent — for certain credit cards, home equity lines of credit and many other consumer and business loans — would drop by a corresponding amount.

Some believe rates could be slashed soon by as much as a full percentage point to 1 percent in hopes of encouraging people and businesses to spend more, thereby restoring confidence to the system.”

Almost all American home equity lines are pegged to the prime rate. A 4% rate for the most credit-worthy customers would definitely be something to talk about. The only problem – who’s left to qualify for these low rates? And, what banks are willing to offer such loans while cutting the lines on thousands of other customers?

See Also:

Will Federal Rate Cuts Affect Your HELOC APR?

How to Negotiate the Best Home Equity Rates and Terms

Today’s Prime Rate

CNN Money reports:

“HELOCs can be hard to get right now, but they are cheaper than doing a complete refinance. Recently, the average rate on a HELOC was 5.73%, a point lower than the new jumbo loans. What’s more, HELOC generally have no upfront fees. The rub is that HELOCs are adjustable, but with the economy looking sluggish it’s a good bet interest rates won’t rise soon.”

If you qualify to take out a home equity line and you live in an area that is not experiencing dramatic property value drops, it’s worth looking in to.

HELOCs have great rates now. But there are more stable options such as the fixed-rate home equity loan.

See Also:

Is a HELOC Right for You?

Current HELOC Prime Rate

Some analysts speculate that this latest cut will be the last for some time. The federal funds rate is already very low and further decreases could escalate inflation.

The official statement from the Federal Reserve seems to indicate that they will proceed with caution in regard to additional cuts:

“Although readings on core inflation have improved somewhat, energy and other commodity prices have increased, and some indicators of inflation expectations have risen in recent months. The Committee expects inflation to moderate in coming quarters, reflecting a projected leveling-out of energy and other commodity prices and an easing of pressures on resource utilization. Still, uncertainty about the inflation outlook remains high. It will be necessary to continue to monitor inflation developments carefully.

The substantial easing of monetary policy to date, combined with ongoing measures to foster market liquidity, should help to promote moderate growth over time and to mitigate risks to economic activity. The Committee will continue to monitor economic and financial developments and will act as needed to promote sustainable economic growth and price stability.”

The benefit for current HELOC borrowers may not be immediate. To learn more about how these rate cuts may affect you see: Will Federal Rate Cuts Affect Your HELOC APR?

“BankRate.com pegs the rate on a $30,000 home-equity line of credit at 5.52%, on average, down sharply from a week ago and, more importantly, about 0.25 percentage point lower than the average 30-year fixed-rate mortgage.

For consumers who have not loaded up on home-equity debt in the past, that picture creates an opportunity.

“Whenever you can lower your payments and lower your interest rates at the same time, you should go for it,” says Paul Richard, director of education at the Institute for Consumer Financial education in San Diego. “Between all of the scary news on Wall Street and how little you can make on savings, this is a good time to get a plan for paying off your debt.”

Of course, not everyone can qualify for a HELOC – especially considering dropping home prices and tightening lending standards. Those who can may find even lower rates should the fed make further cuts in coming months.

See Also:

Fed Cuts Interest Rates, Yet Again

Will Federal Rate Cuts Affect Your APR?

Rates on home-equity lines of credit have dropped to 6.27% from 8.25% since September of last year, according to Bankrate.com. Partly as a result, the amount that homeowners borrowed against their lines of credit rose slightly in the fourth quarter of 2007 — the first such rise since early 2005, according to data from Equifax Inc. and Moody’s Economy.com. Rates on home-equity lines of credit should fall further after the Fed’s latest cuts, but that might have less effect than would ordinarily be expected, as some banks make these loans harder to get…

Indeed, mortgage brokers say their customers are having a harder time borrowing against the equity in their homes. “We’re seeing a lot of lenders freezing whatever is outstanding,” says Mitch Ohlbaum, a mortgage broker with Legend Mortgage Corp. in Los Angeles. He says some clients, worried about getting cut off from existing lines of credit, have started drawing down their lines in a pre-emptive move.

“They’re putting the money into savings accounts and CDs because they’re afraid they’re going to lose access to the funds,” he says. “It’s their safety net.”

It can be difficult to qualify for a HELOC in today’s market, but it’s not impossible. Even Countrywide (who sent out over 100,000 HELOC freeze notices earlier this year) is still advertising for new home equity borrowers.

See Also:

Will Federal Rate Cuts Affect Your HELOC APR?

What to Do if You’re Hit by the HELOC Freeze 

The New York Times Reports:

“Though it was one of the biggest one-day rate cuts in decades, investors had been betting heavily that the Fed would cut its key rate a full percentage point in response to strong evidence that a recession has begun and to the deepening crisis on Wall Street…

Some saw the cut of three-quarters of a point as a compromise to appease those who wanted less. Others surmised that the Fed may have been reluctant to cut rates further immediately in part because as the rates inch closer to their floor of zero, the Fed leaves itself less room to maneuver in case of further financial shocks.”

If you have a HELOC based on the prime rate, this federal rate cut may end up reducing your monthly interest payments.

For those who can qualify with the tough new lending standards, now may be a good time to take out a home equity loan. If the New York Times article is any indication, more rate cuts may follow in the coming months.

See Also: Will Federal Rate Cuts Affect Your APR?

To understand how this works, you’ll need to comprehend three terms: index, prime, and margin. Read more…