The residential real estate market for new purchases shows no signs of slowing down even as interest rates on 30 year, fixed rate mortgages head into the 5s. However, for many current homeowners, there may be a looming upcoming and unpleasant, interest rate surprise. Over the years, due to low interest rates, homeowners have been tapping the equity in their homes for renovations, debt consolidations, college tuition and investments.
A lot of this equity, was taken out through home equity lines of credit or "HELOCs" since they usually only require interest only payments for the first 10 years; have low interest rates and little or no closing costs. The catch though, on all of these HELOCs, is that the interest rates adjust monthly based upon the Prime interest rate.
As the rates on the HELOCs are generally somewhere between Prime and Prime plus 1 or 2%, this has been fine while the interest rates have been low. Currently, Prime is still only 3.50%. However, with inflation where it is now, the Fed is poised to raise rates a number of times this year (and possibly next year as well). When they do, the Prime Rate will be increasing concurrently with and in the same amount as each Fed increase.
For every 1% increase in the Fed Funds Rate (and correspondingly the Prime Rate), the HELOC payments will increase $80 per month, per $100k of debt. So, with a 2% increase in the Fed Funds Rate, on a HELOC amount of $250k, the interest only payment will increase by $400 per month. If the HELOC is over 10 years old, and has entered the principal repayment phase, the increase will be higher.
So, with those increases looming, even with higher fixed rates, depending on the balances of the mortgage v. HELOC, it could still make sense to consider consolidating the HELOC into a 15, 20, or 30 year fixed rate loan. In any event, it is definitely worth knowing about this and being aware of the risks of a HELOC at this point. As always, I am happy to discuss this any time and analyze the potential loan options.
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