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Accessing home equity when interest rates are high


When you need help with an expense, your home’s equity can be a great source of funds. But with interest rates the highest they’ve been in 15 years, now may not seem like the best time to refinance, take out a home loan or get a line of credit. That’s why weighing your options is vital to avoid ending up in worse financial shape than you were before you tapped into your equity.

A HELOC offers a lower rate, but fluctuating payments

A home equity line of credit (HELOC) can be a good choice if you don’t know the exact amount you need to cover your expenses. You draw how much you need from your line of credit when you need it, and you make interest-only payments during a draw period that’s typically the first ten years of the loan.

HELOCs typically come with a variable interest rate, which often starts slightly lower than a fixed-rate home equity loan. But changes to the prime interest rate set by the Federal Reserve can raise your variable rate, your interest-only payments and eventually your amortized payments during the HELOC’s repayment period. HELOCs also traditionally come with an annual fee that is added to the overall cost of the credit line.

The best HELOC lenders offer a fixed-rate option, which allows you to convert a portion of what you’ve drawn into a fixed-rate loan with a term separate from the term of your HELOC. Taking advantage of that option when rates are lower can help stabilize your monthly payments and make your HELOC less expensive in the long run.

Home equity loans offer fixed — but higher — rates

A home equity loan may be the best choice if you know exactly how much money you need. With this fixed-rate option, you may pay a slightly higher interest rate at first, but your monthly payments are stable for the life of the loan, which can make budgeting a lot easier.

Both HELOC and home equity loan programs tend to waive closing costs, as long as you keep the accounts open for three years. And both offer a tax benefit, with the IRS allowing you to write off the interest on the loan or line of credit as long as you use the money to “buy, build or substantially improve” your home. A difference with a home equity loan is that you won’t pay an annual fee, which lowers the overall cost of the loan.

High interest rates make refinancing costly

When interest rates are high, you may want to consider refinancing your mortgage for cash as the option of last resort. A cash-out refinance loan can be easier to qualify for than a HELOC or home equity loan, and it often comes with lower rates. But a refinance is much more expensive in the long run. You’ll pay not only closing costs, but also a higher interest rate on the total amount of your mortgage for the life of the loan, which can add up.

Say you need $40,000 from your home equity. You’ll pay more for a cash-out refinance than for a home equity loan on your existing mortgage, even if the equity loan’s interest rate is much higher than the rate for the refinance.

If your refinanced loan is $200,000 at 8% interest, your base monthly payment would be $1,467.53. But if you kept your original $160,000 loan at 5% interest and added to it a $40,000 home equity loan with an 11% interest rate, your $858.91 payment plus the $380.93 loan payment would bring your total monthly payment to $1,239.84 — saving you more than $200 a month.

With the Fed indicating that it’s not quite done raising interest rates, you may want to consider that kind of savings when you choose how to access your home equity. And be sure you’re using that equity wisely.

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