Convertible Fixed-Rate HELOCs: How Do They Work?

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Unlike standard variable-rate home equity lines of credit (HELOCs), HELOCs that have a fixed-rate conversion option allow borrowers to convert some or all of their draws into fixed-rate loans. These are often referred to as "fixed-rate HELOCs" or "Convertible HELOCs."

However, these hybrid fixed-rate HELOCs differ from true fixed-rate lines of credit, which feature one interest rate for all draws no matter when they occur. True fixed-rate lines of credit are rare, and are mostly offered by personal lenders charging rates significantly above the market average. True fixed-rate HELOCs are unheard of in the mortgage industry. When we refer to fixed-rate HELOCs in this guide, we refer to HELOCs with fixed-rate conversion options.

How Does a Fixed-Rate HELOC Work?

Fixed-rate HELOCs behave like standard lines of credit with variable rates, but they offer a fixed-rate conversion option which lets you secure a fixed rate on some of your credit draws, often in exchange for a fee or spread. The benefit of these hybrid fixed-rate HELOCs is that they allow you to guard against unexpected changes in interest rates, which may increase your borrowing expenses.

Depending on the specific terms of your fixed-rate HELOC, you may be able to lock in multiple draws over time at different fixed rates. For example, Chase Bank's Fixed-Rate Lock Option permits up to five outstanding locks at any given time over the life of your credit line. Note that the fixed-rate conversion option is usually exercised on only a portion of your credit line.

For example, if you have a HELOC with a $100,000 maximum credit line and you want to fund a $40,000 kitchen remodeling project when interest rates are at 5%, you can draw $40,000 and lock in the fixed rate at 5% until you fully repay it. Any new draws on the remaining $60,000 in equity will remain subject to the variable rate.

How Do You Convert a HELOC to a Fixed Rate?

Once you've decided to convert a portion of your HELOC to a fixed rate, there's no need to submit a new loan application. Usually, you'll contact the lender and ask to lock in a fixed rate for a certain draw amount. This may cost you extra charges such as a conversion review fee or a rate-lock fee. Before locking in a fixed rate, you should also consider any additional requirements, like minimum balances that can be converted, annual caps on the amount of funds you can convert and the total number of conversions you're allowed.

If the fees and other requirements are acceptable, the next step is to consider your interest rate and desired term. The fixed rate is determined by the prevailing market rates at the time of conversion, based on the loan term you choose, plus a premium for the rate lock. After requesting the conversion from your HELOC provider, you may need to sign a rate-adjustment agreement that lists the new rate and term.

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Pros and Cons of a Fixed-Rate HELOC

Hybrid fixed-rate HELOCs offer borrowers flexibility and options on how to repay their loans. They are useful for meeting large expenses with undefined costs, like home repairs or renovations that may require an extended period of time. Since a fixed-rate conversion allows you to lock in the interest expense of each subsequent draw, you can take multiple lump-sum draws with the knowledge that your debt won't suddenly increase. For the same reason, a hybrid fixed-rate HELOC can also help you avoid volatility in the market.

However, one of the downsides to the fixed-rate conversion is that the rate you lock may hurt rather than help. The lock rate offered by your lender may exceed both the market rate for a similar home equity loan and the variable rate you were paying originally. This is because lenders often charge a spread for the long-term certainty of a fixed rate. In addition, a rate lock can cost you additional fees which will raise the true cost of your loan.

Standard HELOCs vs. Fixed-Rate HELOCs

Fixed-rate HELOCs may not be a good idea if you don't draw on your HELOC very often. It may also be a bad choice when interest rates are low and your variable rate is significantly lower than the fixed rate you would pay upon conversion. In such cases, you may be better off getting a standard variable-rate line of credit or ignoring the conversion option on your existing HELOC. By contrast, fixed-rate HELOCs can be useful assets when you have large outstanding balances in times when market rates might rise.

Fixed-Rate HELOCs vs. Home Equity Loans

If you can benefit from getting a fixed rate on a lump-sum payment, you can also consider a home equity loan. Rates for a home equity loan are often lower than those on a HELOC fixed-rate conversion. Home equity loans lack flexibility and usually have higher closing costs, but they make more sense if you're funding a large and well-defined one-time cost.

Depending on the trend in interest rates, some borrowers find that a home equity loan lets them recoup their closing costs and save more over the life of the loan than if they had drawn the same amount from a HELOC. Relative to a home equity loan, corresponding conversion fees and above-market rates on fixed-rate conversions can erode any savings you might gain through a fixed-rate HELOC.

Fixed-Rate HELOCs vs. Cash-Out Refinance

Borrowers who want to refinance their entire home but still wish to cash out on their existing equity, might be better served by doing a cash-out refinance on their homes. A cash-out refinancing can serve three purposes:

  1. Refinances your entire mortgage at the current market rate
  2. Lets you take on extra debt and roll it into your newly created mortgage
  3. Eliminates burdensome requirements like PMI, which may be required for programs like FHA loans

With a cash-out refinance, not only could you achieve a lower rate on your new mortgage, but you could also take advantage of that new rate by cashing out on some of your home equity. The downside is that a cash out refinance behaves like a refinancing with a lump sum cash payout, which may not be ideal if you intend to fund multiple expenses over a long period of time, or don't know how much cash you will need.

By comparison, a fixed-rate HELOC gives you more flexibility to draw cash on multiple occasions, and avoids the need to pay interest on undrawn balances. However, a fixed-rate HELOC still subjects you to fluctuating interest rates at each subsequent draw and may entail additional fees each time you need to exercise the conversion option. If you need to exit burdensome HELOC terms later on, keep in mind that you can also refinance your HELOC down the line.

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Editorial Note: The editorial content on this page is not provided or commissioned by any financial institution. Any opinions, analyses, reviews, statements or recommendations expressed in this article are those of the author alone, and may not have been reviewed, approved or otherwise endorsed by any of these entities prior to publication.

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