Pros and cons of a home equity line

Rates on credit lines have been rising for a year and a half. Meanwhile, long-term mortgage rates have been falling for a month and a half. This up-down combination gives borrowers a chance to pay off their credit lines with other types of loans.

To decide whether it makes sense to ditch your credit line, you have to do some math and think about the price you're willing to pay for the flexibility of having a credit line.

If the math in this article makes your head hurt, you can ask a mortgage broker or loan officer to crunch the numbers.

Home equity lines of credit, known to mortgage geeks as HELOCs, usually go up and down with the prime rate. The rates on credit lines used to be 2 percentage points lower than rates on 30-year, fixed-rate mortgages, but now they're about 1 point higher. Some borrowers might want to keep their credit lines anyway. Others might benefit from doing what's called a "cash-out" refinance of their primary mortgage _ borrowing more than the outstanding balance on the primary mortgage and using the proceeds to pay off the credit line. Still others might want to swap their credit line for another type of equity debt.

"What I do for people is I look at the weighted average of what their mortgage rate is," says Bob Moulton, president of Long Island-based Americana Mortgage Group. Moulton offers the following example (here comes the math):

Let's say you have a $200,000 primary mortgage at a rate of 5.875 percent, plus a credit line with an outstanding balance of $100,000 at 7.25 percent. First, divide the amount of the primary mortgage ($200,000) by the total debt ($300,000). Multiply that by the rate on the primary mortgage: 0.67 times 5.875 equals 3.94.

Do the same with the credit line. The outstanding amount on the credit line is $100,000. Divide that by $300,000 and you get 0.33. Multiply that by the credit line's rate: 0.33 times 7.25 equals 2.39.

Add those two numbers to get the blended average: 3.94 plus 2.39 equals 6.33. In this example, the hypothetical homeowner is paying a blended average of 6.33 percent on both mortgages. Moulton says he would tell the borrowers that they could do a cash-out refinance and pay off the credit line.

There are reasons to keep a HELOC: You keep a low balance and use it only for emergencies, you periodically draw against it (to pay tuition, say) and pay it back down, or you plan to move out of your home within three years or so. If you plan to stay in the house for five or more years and you keep a balance of many thousands of dollars on your credit line, there are options besides keeping the credit line or doing a cash-out refi.

You could pay off the HELOC with a fixed-rate home equity loan. The equity loan's rate will be higher, but it won't change. The prime rate, on the other hand, is expected to rise to 7.5 percent or 7.75 percent early this year. Another option is to get a hybrid HELOC. Wells Fargo is the only nationwide bank to offer such a loan, which it calls the SmartFit Home Equity Account. It has some features of a fixed-rate home equity loan and some features of a variable-rate equity line of credit.

SmartFit is a line of credit that you can draw from over and over again. When you draw from it, the interest rate on that sum is fixed for three, five or seven years, depending on what you choose. During that time, you can pay only interest or interest plus principal. At the end of the fixed period, the rate on that portion of the balance moves up and down with the prime rate, or you can convert it into a fixed-rate advance.

It's a good deal for people who don't want to pay 30 years of interest on the things they buy with their lines of credit, says Doreen Woo Ho, president of Wells Fargo's consumer credit group.

Customers usually have a purpose for their credit lines, such as buying cars or renovating their homes, Woo Ho says, "and many customers see it as something that they want to pay off sooner."

X X X

The benchmark 30-year fixed-rate mortgage fell 1 basis point to 6.27 percent, according to the Bankrate.com national survey of large lenders. A basis point is one-hundredth of 1 percentage point. The mortgages in this week's survey had an average total of 0.27 discount and origination points. One year ago, the mortgage index was 5.81 percent; four weeks ago, it was 6.39 percent.

The 15-year fixed-rate mortgage fell 4 basis points, to 5.82 percent. The 5/1 adjustable-rate mortgage fell 4 basis points, to 5.78 percent.

(Distributed by Scripps Howard News Service. E-mail Holden Lewis at hlewis@bankrate.com)

Back to contents of this section