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| The Basics | How to save on your home-equity debt
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Thanks to an odd twist in interest rates, you could save thousands each year just by converting your home-equity line of credit to a closed-end loan or refinancing your mortgage to pay it off.
By Liz Pulliam Weston
People with big home-equity debts may have an unusual opportunity right now to lock in some savings.
The rates on home-equity lines of credit, generally referred to as HELOCs, have climbed two full percentage points in the past year and are expected to rise some more. At the same time, longer-term mortgage rates have dropped.
This has created a rare situation where long-term borrowing can cost less than short-term borrowing. As a result, some mortgage experts are recommending that those with big HELOC balances consider locking in current rates -- either by converting their debt to a closed-end home equity loan or by refinancing their primary mortgage to a larger loan that would encompass the home-equity debt.
"We're talking about going for the safety of a fixed rate, while the getting's good," said Jack Guttentag, a nationally syndicated mortgage columnist and professor emeritus of the Wharton School of the University of Pennsylvania. "I think a strong case can be made for that."
Greater equity risk with HELOCs
HELOCs, a kind of adjustable-rate mortgage that allows homeowners to borrow against the equity in their home, expose borrowers to more interest-rate risk than most other kinds of mortgages, Guttentag said. They typically have no payment caps and their maximum interest rate is high -- usually 18% or more. Furthermore, HELOCs respond quickly to changes in short-term rates.
"If the prime rate goes up on a Monday," Guttentag said, "your (HELOC) rate is up on Tuesday."
Closed-end home-equity loans, by contrast, offer a fixed rate (currently averaging just over 7%, compared to about 6.25% for the average HELOC after its teaser rate expires). You may face higher payments, though, because home-equity loans require principal payments as well as interest. (HELOCs typically require you to pay only interest in the initial years).
Wrapping your HELOC into your mortgage
The other option: paying off your HELOC balance with a cash-out refinancing of your primary mortgage.
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Here's how it might work. A couple with a $75,000 HELOC balance at 7% might refinance their $200,000 mortgage into a new, $275,000 loan at 5.5%. They might not save much on their original loan, particularly if it already had a low rate. But they've nailed down a lower rate on the HELOC debt that could save $1,125 a year.
If short-term rates continue to climb this year, as many experts expect, the savings could be even greater.
"The thinking is that the Fed will raise rates another quarter point at the end of the month, and there may be another couple of increases beyond that," said mortgage broker Allen Bond, who serves on the California Assn. of Mortgage Broker's board of directors. "So you could be looking at rates that are three-quarters to a point higher by year end."
Will it pay off for you?
Whether the math works for you, however, depends on a number of factors:
How much do you owe? The smaller your balance, the less your exposure to interest-rate risk -- and the less sense it makes to bother with a cash-out refinance. You might decide to convert a $10,000 or $20,000 HELOC balance to a closed-end home equity loan, but you need a bigger balance to justify the costs involved with a refinance, Guttentag said.
"We're really talking about balances over $50,000," Guttentag said.
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MSN Money's editorial goal is to provide a forum for personal finance and investment ideas. Our articles, columns, message board posts and other features should not be construed as investment advice, nor does their appearance imply an endorsement by Microsoft of any specific security or trading strategy. An investor's best course of action must be based on individual circumstances.
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