How to choose the right HELOC when rates are high
Home values have skyrocketed in most markets across the nation over the last few years, leaving the average homeowner with a substantial level of home equity. And, when homeowners gain equity in their homes, it opens the door to borrowing from that equity for any number of expenses, from home renovations to education cost and start-up business expenses to consolidating high-interest debt.
And, if you want to borrow from your home's equity, there various ways to do that, from home equity loans to cash-out refinances and home equity lines of credit (HELOCs). Of the different options for tapping home equity, though, HELOCs offer unique advantages, especially in today's economic environment. With a HELOC, you're given a line of credit to borrow from, and you can draw funds from that credit line as needed up to your credit limit, only paying interest on the balance you utilize.
However, today's economic landscape, marked by high inflation and elevated interest rates, has created new challenges for those considering HELOCs. After all, while HELOC rates are still lower than most other borrowing products, HELOC rates have risen sharply in tandem with the broader interest rate hikes — and now top 9% on average. In turn, it's important to take steps to secure the best possible HELOC option in today's elevated-rate environment.
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How to choose the right HELOC when rates are high
If you want to borrow money from your home's equity, here are some tips that can help you choose the right HELOC in the current high-rate landscape:
Understand the HELOC rate structure
Most HELOC rates are variable, meaning that the rates adjust periodically based on the wider rate environment. So, before borrowing, make sure you understand how often your rate can change and consider tying yourself to a HELOC with a periodic or lifetime interest rate cap that limits how high your rate can go.
Don't just look at the initial rate, either. Ask lenders to explain the index and margin that determine your fully indexed HELOC rate over time. For example, if the HELOC uses the prime rate + 1% margin, your rate can adjust whenever the prime rate changes.
Find out what home equity loan and HELOC rates you qualify for now.
Compare rates from multiple lenders
Just as you would shop around for the best mortgage rate, you should get HELOC quotes from at least three to five different banks and lenders. After all, HELOC rates can vary significantly between institutions, as each lender sets its own rates, and may differ by 1% to 2% or more across different banks and lenders. And remember that you don't need to use your current home lender.
Consider an interest-only HELOC during the draw period
Most HELOCs allow interest-only payments for the initial draw period before entering full principal and interest repayment, which can meaningfully reduce your upfront payment burden. So, while you'll eventually need to repay principal, selecting an interest-only HELOC during the initial draw period can help keep costs down while rates are elevated.
Look for a fully-indexed rate
Some HELOCs offer a discounted teaser rate for a period before switching to a higher fully indexed rate later on. In many cases, it's wise to avoid these and opt for a HELOC with a fully indexed rate based on transparent indexes from the start. That way, there are no expensive surprises down the road.
Find a HELOC without inactivity fees
It's common for HELOC lenders to charge inactivity or annual fees if you don't draw or maintain an outstanding balance. There's no need to pay for those extra expenses, especially in today's elevated rate environment, so be sure to look specifically for HELOCs with no inactivity fees to help keep the overall costs down.
Lock a portion of your HELOC with a fixed-rate option
Some lenders give HELOC borrowers the ability to lock in a fixed rate on part of their balance to create more payment certainty. This can help insulate you from future rate hikes if they occur.
Compare upfront and ongoing fees
In addition to comparing the rates on HELOCs, carefully review all upfront closing costs, like origination fees, appraisal fees and other charges, along with any ongoing annual fees lenders charge. Add these into your overall cost calculation to determine which HELOC makes the most fiscal sense.
Evaluate draw flexibility
Some HELOCs restrict how you access funds. For example, a HELOC may come with a $5,000 draw amount minimum or have a limited number of draws allowed. To maximize the potential of your HELOC, make sure that any option you consider allows flexible draws of any amount at any time.
The bottom line
While elevated interest rates have made HELOCs more expensive compared to recent years, they can still make sense if properly utilized, especially considering that the rates on HELOCs are still lower than most other borrowing options right now. And, by shopping around for the best offers, understanding the borrowing terms and knowing what to look for, you can use a HELOC to put your home equity to work in the right way, even in today's higher rate environment.
