Summer is coming, and homeowners may be contemplating remodeling projects and household repairs during the warmer months. But with interest rates starting to rise, consumers should carefully consider their financing options.
The recovery in housing prices means that more people have equity in their homes that they can tap for projects such as adding a bathroom or updating a kitchen. As interest rates tick upward, though, homeowners may want to consider whether to draw on that equity for a remodel.
"I do think the rate landscape is a factor at this point in time," said Greg McBride, chief financial analyst at Bankrate.com.
Mike Kinane, general manager for home equity products with TD Bank, said he did expect that "consumers will be borrowing against their homes" for remodeling projects.
If you have the cash, it's wise to consider using it, because interest rates paid on savings are still quite low, said Robert Schmansky, founder of Clear Financial Advisors, outside Detroit. If you must finance the work, then a home-equity loan or line of credit "isn't the end of the world," he said, although he suggested paying it down as quickly as possible.
With interest rates trending up, refinancing an existing mortgage to take out cash for a remodeling is becoming less attractive.
Home-equity lines of credit, which function like a credit card rather than a traditional term loan, have been one of the most popular ways to finance remodeling. Lines of credit, or HELOCs, however, come with variable interest rates, typically tied to the prime rate. That means monthly payments will rise if the interest rate on the loans increases.
Lines of credit typically have a 10-year "draw" period, during which borrowers use the available funds as necessary and make interest-only payments. After the draw period, the lines usually convert to regular installment loans, with monthly payments of both interest and principal required over another 10 to 20 years.
The average rate on a home equity line of credit is 5.45 percent, McBride said, although some lenders offer initial "teaser" rates as low as 2.99 percent.
Before the financial crisis, as home values skyrocketed, borrowers used the lines to finance all sorts of things, from vacations to new cars. But since the recession, borrowers have been using the lines more responsibly, to fund specific upgrades on their homes or to pay for college costs, Kinane said. The average amount of the credit line is about $50,000 nationally.
Home-equity loans — a traditional second mortgage, typically made at a fixed-interest rate — may be more palatable than lines of credit as rates rise.
Kinane said he had seen a "very slight uptick" in applications for home equity loans as borrowers react to rising interest rates.
But many larger banks stopped making home equity loans, preferring to offer lines of credit, which reduce risk to the lender from rising rates. The choice is ultimately dependent on the consumer's risk tolerance.
One more way to manage the risk of rising rates: Many lenders offer the option of converting the amount of money that you have already drawn from a line of credit into a fixed-rate loan to lock in a rate.
Ann Carrns writes for the New York Times.
