A borrower reached out to me for a Home Equity Line of Credit (HELOC) recently, and I referred her to a local bank that we work with that offers the best service and rates.
She came back to me the next day and said: “my friends say I should consider a cash-out refi instead…”
And – I thought, “ouch, I may be the worst loan advisor ever…” – because I should have been as smart as her friends.
HELOCs Can Be Very Dangerous With Inflation Looming
This is a quick reminder that ALL HELOCs are adjustable rate loans.
TIED TO PRIME RATE: They are tied to Prime Rate – which has been 3.25% for years and very stable for the last 30 years.
MARGINS: The higher LTV (above 85%) HELOCs also have “margins” that range from 0.5% to 5%, depending on credit score and loan amount. As a reminder, a HELOC borrower’s rate is calculated by adding the margin to Prime Rate.
LIFE CAP: Most HELOCs have very high “Life Caps” (the maximum allowable rate) too – often as high as 18%!
LONG STORY SHORT: Borrowers looking for an equity line may be better off with a cash-out refi, depending on the amount of cash needed, even if they end up with a higher rate. This is because significant inflation is on the horizon and inflation almost always pushes up interest rates and Prime Rate in particular (Prime was over 20% in 1981 and well over 8% for most of the 1980s).
Cash-out refis come with 30-year fixed- rates that will remain the same no matter what inflation does.
PMI Instead Of HELOCs
Borrowers may also want to consider Private Mortgage Insurance instead of 1st/2nd combo (with a HELOC 2nd) financing now too – in an effort to avoid variable rate debt. PMI can be eliminated in a few years in many cases, with only the fixed-rate loan remaining.
HELOCs Not All Bad
Sometimes HELOCs are still necessary to make financing work, and they are not all bad – particularly now while Prime Rate remains at 3.25%*.
But, borrowers should have plans to pay them off as quickly as possible.
A $200,000 HELOC might only have a $667 “interest-only” payment now, but if inflation sets in and rates hit double digits that payment could easily jump to $2,000 per month.
Borrower With A $400,000 Purchase Money HELOC
And finally, we just had a borrower lock in a refi with a higher fixed rate because he wanted to consolidate his 1st and 2nd ($400,000 HELOC) into one loan – because he was so concerned about inflation.
For HELOC borrowers with high balances that they cannot pay off in the near future, a consolidation loan is probably a prudent move – even if the rate is a bit higher.
Founder/Broker | JVM Lending
(855) 855-4491 | DRE# 1197176, NMLS# 310167