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A Home Equity Line of Credit (HELOC) works the same way as a credit card – it’s a revolving source of funds that you can use at any time with an amount based on the equity in your home – the current home value minus remaining mortgage balance.
Most HELOCs have adjustable rates that fluctuate with market trends. But a fixed rate HELOC allows you to lock in the rate on all or part of your available credit balance.
To find out which HELOC is right for you, let’s dig deeper into fixed rate HELOCs (compared to other products) and how they work.
How a fixed rate HELOC works
With a fixed rate HELOC, you can request that some or all of the borrowed funds be subject to a fixed interest rate. You then have the option of repaying the amount over a number of years.
If approved by the lender, you can generally access up to 80% of the equity in your home with a HELOC.
There is a drawdown period, usually no more than ten years, which is the period during which you can access the funds as needed. Any payments you make during this time will only apply to the interest charged on the money you withdraw.
This is followed by the repayment period, usually no more than 20 years, when you no longer have access to the money and have to make monthly payments on the amount borrowed plus interest.
One caveat: Taking out a HELOC means putting your home as collateral, and your lender can repossess the collateral if payments aren’t made. This means that failure to make the required payments can result in default or foreclosure.
It is important to remember that each financial institution will have different terms governing how you can access your line of credit. Also, you can expect some variation in the interest rates and fees charged by each lender. So be thorough in your research. Here are some examples of what to expect:
- HELOCs can be fixed rate when you close the line of credit, or you can choose to convert from a variable rate HELOC during the drawdown period.
- You may need to borrow a minimum amount in order to get a fixed rate.
- You may be able to lock in a fixed rate for the entire loan balance, or only a portion of it.
- The fixed rate HELOC is generally blocked for terms ranging from five to 30 years.
Although the fixed rate HELOC has the same general characteristics from bank to bank, there may be critical differences between one product and another, which makes it better suited to your needs. So be sure to shop around and pay attention to every detail before making a decision.
Fixed rate or variable rate HELOCs
As mentioned, a HELOC usually comes with a variable interest rate. This means that your payments can go up or down based on current market rates. The fixed rate option, on the other hand, locks in an interest rate for part or all of the life of the HELOC.
The bank sets the loan limit based on the equity in your home. It then sets the interest rate, which is usually based on the prime rate as well as your creditworthiness and financial profile.
While most HELOCs have variable rates, more and more lenders are also offering fixed rate HELOCs. Deciding which one is best for you really depends on current market rates and how comfortable you are with the risk you would like to take.
For example, when rates are low and you are worried they will go up, you might consider locking in a rate with a fixed rate HELOC. However, if rates drop further, so will your rate if you have a variable rate HELOC that fluctuates.
Related: Compare current mortgage rates
Advantages and Disadvantages of Fixed Rate HELOCs
As with any loan option, there are always pros and cons to each product. We will explain both to you when it comes to a fixed rate HELOC.
Benefits of a fixed rate HELOC
- The fixed rate means that your payments won’t suddenly increase if market rates rise.
- You don’t have to worry about low introductory rates which are designed to attract new customers and which will increase after the promotion period ends.
- As you pay off the fixed rate HELOC balance, your available line of credit increases.
- You only pay interest on the amount you draw, as opposed to the entire balance.
- If the funds are used for a home improvement project, the IRS considers your interest payments to be tax deductible.
Disadvantages of a fixed rate HELOC
- It may have a higher starting interest rate compared to a variable rate HELOC.
- You could find yourself stuck in a higher interest rate if market rates fall.
- A potential spike in your monthly payments after the drawdown period is over, as you are now paying off the full balance and interest.
Is a fixed rate HELOC right for you?
If you need cash for a home improvement or renovation project, but dislike fluctuating monthly payments, a fixed rate HELOC may be a good idea. It will provide you with the funds you need and offer transparency about your monthly payments. Plus, spending money on an addition to your home means the interest payments are tax deductible.
But keep in mind that if you want to purchase a fixed rate HELOC for other purposes, it is not tax deductible and poses a certain risk if you cannot make payments later.
As with any HELOC or loan product, be sure to do your research first, compare different lender rates, and take stock of your financial situation before closing.