Traditionally, if you wanted to borrow against the equity in your home, you could either get a fixed-rate home equity loan or draw money against a home equity line of credit (HELOC), a closed-end line of credit with a variable interest rate. Now there’s a third choice: the HELOC fixed-rate option. In fact, some of the biggest lenders, such as Bank of America Corporation and Wells Fargo & Company, have used it to replace home-equity loans, possibly because of new mortgage regulations they might find burdensome.
This hybrid product has its own quirks, benefits, and drawbacks, not to mention that different lenders have different rules about how you can use it. Here’s what you need to know about how this type of loan works. (For some background first, see "Choosing a Home-Equity Loan or Line of Credit.")
Some lenders brand this product with special names (case in point: Santander’s FlexLock Home Equity Line of Credit), but the HELOC fixed-rate option generally works the same way no matter which lender you choose. There are important differences in the details that might make one lender’s product better for your situation than another’s, however (as if comparison shopping for a loan weren’t complicated enough already).
The basic premise is that you get a line of credit based on your home equity and you can borrow against little or much of that credit line as you want. Your interest rate will change with market conditions, which can mean major variations in your monthly payments and in the total amount you owe over time. To reduce the uncertainty, tell your lender that you want all or part of the sum you’ve borrowed to be converted to a fixed-rate loan at the market’s current interest rate. You’ll pay back that amount over a set number of years, and you can keep borrowing if you still have funds remaining in your credit line. Unlike with a traditional home-equity loan, you aren’t shut off from access to further credit and, as you repay the fixed-rate balance, your credit line goes back up.
Here are some examples of the HELOC fixed-rate option features that vary by lender.
The length of the fixed-rate term: Lenders will let you fix your rate for anywhere from one to 30 years. The longer the term, the smaller your monthly payment, but, all else being equal, the more interest you’ll pay. You may be limited in the term you can choose. For example, one lender might limit your choices to a three, five or seven-year term on a fixed-rate, interest-only lock, whereas if you pay both principal and interest, you can choose any term you want within the allowed range.
Number of fixed-rate balances: The more fixed-rate balances you can carry, the better. Check if the lender charges for this increased flexibility through a higher interest rate or fees.
Minimum fixed-rate balance: Your lender may require that you borrow a minimum amount if you want to lock in a fixed rate. Keep in mind that lenders also require you to borrow a minimum amount on a traditional home-equity loan, and may have minimum withdrawal requirements on traditional HELOCs.
Annual limits: Some lenders cap the number of fixed-rate balances you can lock in each year. For instance, you may be able to carry three fixed-rate balances total, but only create two new ones in the same year.
When you can convert: You can usually convert all or part of your HELOC balance to a fixed rate with a definite term at closing or anytime during the draw period. You can’t convert during the repayment period; at that point, you’ll have to refinance if you want to convert a variable-rate balance to a fixed-rate one. (See "Refinancing Your Home-Equity Loan: A How-To Guide.")
Fully amortizing or partly amortizing term: A fully amortizing term means you’ll pay off the whole fixed-rate balance during the fixed-rate term; a partly amortizing term means you’ll still have an outstanding balance at the end of the fixed-rate term, which will then revert to a variable rate. Taking longer to pay off your balance means paying more interest, especially if the variable rate it reverts to is higher than the fixed rate you were paying. (For more, see "How HELOCs Can Hurt You.")
Switching back to a variable rate: Some lenders will let you convert your fixed-rate loan back to a variable-rate loan anytime during the draw period, which you would want to do if interest rates dropped.
Rate lock fee: Some lenders charge a nominal fee, such as $50 or $100, when you lock in a fixed rate on a balance; others don’t.
Fixed-interest rate: No matter which lender you choose, your credit score and market interest rates will affect what rate you can get on a HELOC fixed-rate option. But, as with any loan, some lenders have lower rates than others. Shop around, and don’t overlook credit unions and small banks; they sometimes have better deals than the big guys.
Scott Nguyen, a 27-year-old real estate investor from Costa Mesa, California, wanted to use some of his home equity for remodeling work. After a lot of research on the pros and cons of home-equity loans versus HELOCs, he chose a HELOC with a fixed-rate option.
“This allowed me to take my time working with contractors to get bids and to get my finances in place,” Nguyen says. “I didn't feel pressured to find contractors right away because I didn't get charged interest until I drew from my HELOC.” When Nguyen was ready to borrow, he used the fixed-rate option. He appreciated knowing his exact payments and used the money to replace his grass with artificial turf and to do a kitchen remodel with new cabinets and granite countertops.
When you can’t decide whether a home-equity loan or a HELOC is the best option for you, a HELOC that lets you lock in part of your balance at a fixed rate is a great alternative. It doesn’t force you to choose between borrowing a large sum now and having the flexibility to withdraw funds as you need them later. It also doesn’t make you choose between knowing your interest rate and taking a chance on market rates. Apply with several lenders to find the best rate and the loan features that are most appealing to you. (For more, see "Is It Time to Get a HELOC?")