If you have a home equity loan or line of credit with a variable interest rate, you've been enjoying some of the lowest rates in history. But variable rates are short-term rates, and many are expecting those to increase before too long. With inflation still on the distant horizon, it might be time to replace your variable rate with a fixed rate mortgage. While rates are still low, here are your options:
First, Check Your Home Equity or HELOC Loan Documents
Many variable-rate home equity loans have provisions for converting some or all of the outstanding balance to fixed rate loans at one or more points during the term of the mortgage. It generally costs little or nothing to exercise this provision. Your conversion rate is determined by a margin, which was specified by your lender when you obtained your loan, and the value of a published financial index. Know, however, that the conversion rate may be no bargain -- finding out what it is may just be your starting point. For example, one borrower who took out a convertible HELOC from a major lender in 2008 discovered that converting it to a fixed-rate loan would increase the interest rate from 3.75% to 9%. If your current loan is not convertible, check with your current lender to see what terms it's willing to offer you to convert your interest rate.
Then, See if You Can Do Better
You may have a few options for exchanging an adjustable rate for a fixed rate. In addition to the HELOC conversion, you can:
- Refinance your HELOC to a fixed home equity loan. Keep in mind that refinancing your HELOC to a fixed-rate loan means you will no longer be able to tap it for emergency cash flow. If that's a concern, you might want to draw on it and place the proceeds in a savings account for easy access.
- Wrap your second mortgage into a new fixed rate first mortgage. Factor in mortgage insurance when analyzing this option if your loan-to-value will exceed 80%. In addition, a new first mortgage carries significant closing costs. This should be part of your calculation as well.
Verify Your Home Equity
You can check with online valuation sites to get an idea of where property values are headed in your area. While these sites aren't completely accurate when valuing a specific property, they are useful for spotting general trends. If your neighborhood has lost 5% of its value, chances are your home has also. If you still have 20% to 25% home equity, you're in a good position to refinance your HELOC or wrap it into a new first mortgage.
Know Your Blended Rate
What's a blended mortgage rate? It's the rate you pay on all of your mortgage debt when you have a first and second mortgage. If trying to determine whether a new first mortgage would be better than keeping your current first mortgage and refinancing your second mortgage, you need to know your blended rate. It's easy to calculate:
- Take the amount of your first mortgage and divide it by the total of your first and second mortgages. For example, if you have a $400,000 first mortgage and a $100,000 second mortgage, you divide $400,000 by $500,000. You get 0.8.
- Multiply that number by the interest rate on your first mortgage. For example, if you're currently paying 6% on your first mortgage, that number (.06 * .8) is .048, or 4.8%.
- Do the same thing with the second mortgage. In this case, you'd divide the $100,000 by $500,000 to get .2; multiply that by the interest rate on your potential second mortgage. If you are offered a fixed rate second at 8.5%, the result would be (.085 * .2) .017, or 1.7%.
- Add the two weighted interest rates up (4.8% + 1.7%) to get a blended rate of 6.5%. So if you could get a no-cost refinance of both loans to a new first mortgage at 6%, wrapping the mortgages into a new loan would be an easy choice.
What if You Can't Refinance?
If you don't have enough equity to refinance your HELOC or home equity loan, or if your credit rating has taken a hit and you don't qualify for the lowest mortgage rates, don't despair. You can pretend that you have a new fixed-rate second mortgage. Use a mortgage calculator to see what your payment would be if you increased your interest rate a few points. Then, make that payment. The difference will go toward reducing your principal balance. That can help you two ways: first, the lower your balance is when rates increase, the less your payment will rise. Second, accelerating your payoff means you'll have enough equity to refinance sooner rather than later. Experts expect short-term interest rates to remain low for another year or two. In that time you may be able to make significant headway with your balance.
Gina Pogol has been writing about mortgage and finance since 1994. In addition to a decade in mortgage lending, she has worked as a business credit systems consultant for Experian and as an accountant for Deloitte.
