Fixed-rate HELOCs: a cross between HELOCs and home equity loans

Rising home values allow homeowners to tap their equity through a home equity line of credit (HELOC). This money can help pay for remodeling, a college education, consolidating debt and other financial needs.

However, when interest rates rise, HELOCs become more expensive and less attractive. A fixed-rate HELOC addresses these concerns by allowing homeowners to fix the interest rate on every draw. But is a fixed-rate HELOC the right choice to access your home equity?

In this article, you'll learn what a fixed-rate home equity line of credit is, how it works and its pros and cons so you can make an educated decision.

Key insights

• Fixed-rate HELOCs enable borrowers to lock in their rates.
• Payments increase if you change from interest-only to fully amortizing.
• Lenders often place limits on minimum lock amounts and the number of total locks you can place.

What is a fixed-rate home equity line of credit?

A fixed-rate home equity line of credit is a hybrid of a HELOC and a home equity loan. You receive a maximum line of credit amount and can decide how much and when you draw from your home equity, as you would with a traditional HELOC.

You can also lock in a fixed interest rate, as you can with a home equity loan, without having to pull all of the money all at once. This is helpful if:

• You want to tap into your equity for different purposes (e.g., paying for college and home remodeling).
• You want to access your equity over a long period (e.g., to make annual tuition payments for a college degree).
• You don't know how much you’ll need to withdraw (e.g., when starting a business).

Because of these shared features, a fixed-rate HELOC is often called a hybrid HELOC.

David Lee, a mortgage loan officer with iQ Mortgage, recommends borrowers get a fixed-rate HELOC "when they are fearful of rising interest rates but aren't sure how much money they'll need to borrow. This option allows them to lock in their rate as they access their equity to give them peace of mind about their monthly payments."

How fixed-rate HELOCs work

A hybrid HELOC begins the same way as a traditional HELOC. While every lender is different, these steps are a basic overview of how fixed-rate HELOCs work.

1. Apply

You apply for a HELOC based on your home's value, existing mortgage balance and the bank's maximum loan-to-value (LTV) ratio. Your credit limit determines how much you can borrow.

2. Withdraw funds

Once the home equity line of credit is approved, you can withdraw money as needed. You can do so by withdrawing money at a branch or by transferring money to your bank account at a branch, over the phone, online or by mobile app. Some banks also issue checks you can use to access your available credit limit.

HELOCs have a certain draw period before they turn into term loans. The typical draw period is 10 years. You can borrow from and generally make interest-only repayments during this time. At the end of the draw period, whatever balance remains becomes a term loan. Usually, this term loan is for 20 years with a fixed interest rate based on the current rates at that time.

3. Lock in your rate

You can request to lock in the rate for some or all of your outstanding HELOC balance based on current interest rates. Rate locks can be done immediately upon withdrawing money or at any point during the draw period. There are many reasons why a borrower would lock in the current rate, including when interest rates are rising or when a borrower wants a fixed monthly payment. Some banks require a minimum draw amount, so you may need to lock in a fixed rate on more money than you want to.

4. Make monthly payments

You make monthly payments on the variable and fixed portions of your balance. In most cases, the variable portion is interest-only, while the fixed portion is repaid over a set period. Fixed-rate HELOC loans act like other common loans, such as auto or student loans. Most banks allow borrowers to choose how long they want to repay the loan.

As you pay down your variable and fixed-rate balances, your available credit increases for future draws.

5. Balance converts to a term loan

At the end of your draw period, the variable portion of your outstanding balance converts to a term loan. After the draw period ends, you can no longer withdraw money from your HELOC. The term loan is a fixed-rate loan with equal monthly payments until the loan is paid in full. Common terms include a 10-year draw period for HELOCs and a 20-year repayment period on the outstanding balance.

Pros of fixed-rate HELOCs

Fixed-rate HELOCs offer many advantages over traditional HELOCs or home equity loans, such as:

• Ability to convert from variable to fixed rates: HELOCs generally offer low rates and interest-only payments, but when interest rates are rising, variable interest rates climb. By locking in a fixed rate, you can avoid future rate increases.
• Ability to choose how much of your balance you want to lock in: Most banks allow borrowers to choose how much of their balance to convert to a fixed rate.
• Protection from inflation: When you lock in a fixed rate, you don't have to worry about how inflation affects your debt payments. Your payment amount will not increase throughout the loan’s term.
• Easy to budget: With a fixed-rate loan, you know exactly how much your monthly payments are, so you can budget for them. Payments on variable-rate balances can change each month, so they’re tougher to plan for.
• Flexible repayment periods: Many lenders allow borrowers to choose their repayment terms, so you can pick a loan period that matches your needs and budget.

Cons of fixed-rate HELOCs

While fixed-rate HELOCs offer many benefits, you should be aware of the downsides before applying for one.

• Fees: Fixed-rate HELOCs may have application fees, annual fees or closing fees, so shop around for the best deal. Some banks also charge fees when you convert your HELOC balance to a fixed rate or pay off your balance early. Ask your lender all of the fees that may apply so you’re not surprised.
• Limit on fixed-rate balances: Many lenders limit how many rate locks you can do at once. However, as you pay off the fixed-rate balance, you can create additional locks.
• Minimum borrowing requirements: Lenders require you to lock in a minimum balance to receive a fixed rate. These minimums vary by bank, so consider this when choosing a lender.
• Inability to take advantage of low interest rates: If you've locked in a higher interest rate, you won't benefit when interest rates fall. That means you may pay more interest over the course of your loan.

When is a fixed-rate HELOC a good idea?

A fixed-rate HELOC is ideal if you:

• Want to avoid rising interest rates
• Want a fixed monthly payment over a set period
• Aren't sure exactly how much money you'll need to borrow
• Want the flexibility to reuse your available credit as you pay down your balance

Fixed-rate HELOCs can be a challenge for borrowers who have trouble making larger monthly payments. A traditional HELOC monthly payment is interest-only on the amount borrowed during the draw period (usually 10 years). However, when you convert your balance to a fixed-rate HELOC, you must start paying principal and interest. This could cause your payment to increase significantly, especially if you choose a short repayment period.

HELOCs can also be a bad choice if you can’t resist overspending. They can offer credit limits of $100,000 or more, depending on your home’s value and how much you owe on your mortgage.

If you spend your equity and can’t make the payments, you could put your home at risk of foreclosure. If you can make the monthly payments but you overspend on frivolous purchases, it could limit your ability to change homes in the future or access your equity in an emergency.

Alternatives to fixed-rate HELOCs

Fixed-rate HELOCs are a solid choice for many homeowners’ financing needs, but they aren't the best choice for everyone. When evaluating your borrowing options, consider these types of loans as well:

• Home equity loan: With a home equity loan, you borrow a specific amount from your home equity and repay it over a defined period. A home equity loan is, like a HELOC, a type of second mortgage.
• Cash-out refinance: Refinancing your mortgage and pulling cash out is a good choice when your mortgage has a high interest rate. This option is for borrowers who want to get cash out of their equity without taking out a second mortgage.
• Credit card 0% APR intro offer: Many credit cards offer 0% APRs on purchases or balance transfers for 12 to 21 months. This is a wise choice if you can repay the balance before the introductory period expires and you incur interest.
• Brokerage account margin loan: Borrowing against the value of your nonretirement account investments can be a good short-term option if your investments have stable value. Be aware that if your investments drop in value, the lender may demand that you add more assets to secure the loan. Otherwise, the lender may sell some of your investments to get your loan back into compliance.
• Reverse mortgage: Older homeowners can tap into their home equity without making monthly payments through a reverse mortgage. However, these loans can be expensive, and the interest charges can erode your home equity, so understand the nuances before proceeding.

Bottom line

A fixed-rate HELOC enables you to access the best features of HELOCs and home equity loans. It allows you to draw money from your home equity as needed and make interest-only payments while your balance is variable. Then, you can lock in a fixed interest rate on some or all of the remaining balance to avoid rising rates and have a consistent monthly payment.

Before pursuing a fixed-rate HELOC, understand any lender restrictions on the minimum amount you need to withdraw to lock your rate, and the number of total locks allowed, as each lender has different rules. While a fixed-rate HELOC offers many advantages, these restrictions, plus higher minimum monthly payments, mean these lines of credit aren’t the right choice for everyone.