Now You Can Get That Home Equity Loan in a Comfortable Hybrid

NEW YORK (MainStreet) — Is it time to take out a home equity loan? Growing numbers of homeowners think so, thanks to rising home values and persistently low interest rates. 

And a relatively new type of home equity line of credit, or HELOC, is especially attractive for some borrowers because it offers a temporary fixed rate.

Nationally, home values have risen for 35 consecutive months ending in February, including a 5.7% gain in 2014, according to CoreLogic, the market-data firm. In fact, average sales prices reached all-time highs in January in New York, Wyoming, Texas and Colorado. Though the average home nationally is still worth 12.7% less than at the peak in April 2006, millions of homeowners who bought earlier, or in the downturn that followed, are in the black, owing less on their mortgage than their home is worth. 

"A dearth of supply in many parts of the country is a big factor driving up prices," said Anand Nallathambi, president and CEO of CoreLogic, in a report on trends. He predicts tight supplies will continue to drive prices up.

That means more and more homeowners will have equity to tap for home improvements, college tuition or emergencies. The latest survey from RealtyTrac showed a 20% jump in HELOC lending in the 12 months ended last June, for the hottest pace in five years.

Traditionally, there have been two types of home equity loans. HELOCs, which account for most of the market, are credit lines the homeowner can tap at will, just like a credit card but with a lower interest rate, typically in the mid-single digits.

Generally, HELOCs start with a low interest rate, then after a few months shift to a floating rate based on the prime rate plus a set number of percentage points. The borrower pays no interest until the credit line is tapped, then risks a rising rate on any balance that is not paid off fairly quickly.

The other option is a home equity installment loan, which is much like a traditional fixed-rate mortgage. The borrower takes out a lump sum at the start and pays a fixed rate for the loan's entire term, usually a higher rate than on a HELOC. Both types of loans use as collateral the homeowner's equity, which is the value of the home less outstanding mortgage debt.

The new twist is a HELOC that for one or more years charges a fixed rate on the initial loan, then a variable rate on money borrowed later and balances that remain after the fixed-rate period ends. 

This type of loan, nearly non-existent in 2010, now accounts for nearly 10% of HELOC offerings, according to HSH.com, the mortgage-information site. 

Wells Fargo, for example, offers a HELOC with a "fixed rate advance" for one, three or five years. Rates are just shy of 3% for 12 months, 3.375% for three years and 5.865 for five years. Currently, the variable rate is 3.25%, though it could be higher if you still had a balance when your advance went from fixed to variable.

Other lenders have different variations on this type of offering.

So who is the ideal candidate for these hybrid loans?

For starters, it would be a homeowner who needs a lump sum right away. In the past, this type of borrower would probably opt for a home equity installment loan, because borrowing a substantial sum on a traditional HELOC would be too costly if HELOC rate were to rise. But with the Wells Fargo hybrid offering, for example, the borrower could pay 3.375% for a year rather than the 5.865% the bank charges for a 15-year installment loan.

Ideally, the borrower choosing a hybrid should plan on paying off the loan balance before the initial fixed-rate period ends.

The hybrid product could also work well for the homeowner who wants to use the untapped line of credit as a backup for emergencies, since it might be hard to get a credit line after a financial setback. One could get a $20,000 credit limit, take $5,000 immediately at a fixed rate, and keep $15,000 of borrowing power in reserve.

Finally, the hybrid would suit the borrower who believes that short-term interest rates will remain low for some time, so the rate would not rise substantially if there were still an outstanding balance after the fixed-rate period ended.

That's a gamble, of course, but not too scary if the borrower had other assets that could be used to pay off the loan if variable rates were to jump.

— Written by Jeff Brown for MainStreet

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