Home equity line of credit and rising interest rates

Should you keep your line of credit?

We have written extensively about the usefulness of a home equity line of credit. The ability to take a portion of the value of your home and borrow against it, only as needed, is a useful one. You can have the credit available to you in case of emergency, loss of job, or for when you decide that you need or want to do a bit of home improvement. A line of credit is a great tool for just about any homeowner.

But the downside to a line of credit when compared to a regular home equity loan is the variable interest rate. The rate for a home equity loan is fixed, as is the payment schedule. It’s like a car payment; you make so many payments at a particular amount and the loan is paid off. With a credit line, you only borrow what you need, when you need it. You pay back on a much more flexible schedule, albeit with a variable interest rate.

And there’s the rub. In the last two years, the Fed has raised short term interest rates some fifteen times in a row. There is no indication that these increases will stop or that rates will go down. So if you have a credit line, you can fully expect the interest rate you pay to continue to increase. Should this be a cause for concern?

That depends on the state of your credit line and what you intend to do with it in the future. If you currently owe nothing and you have the tool just for emergencies or unknown/undefined future needs, you should probably just keep it. You don’t know when you will need it and interest rates may drop by the time you actually do need to borrow. The flexibility and the availability of the product is what makes it appealing, and rising interest rates won’t change that. Keep it, know that it will be there when you need it, and sleep well.

On the other hand, if you have borrowed extensively against your line and you need to pay back a sizable sum, you may have some concerns. Your choices are pretty simple:

Keep going and pay it off - If you like having the credit line available and you want to continue to be able to use it in the future, then make your payments and carry on. After all, even the recent rate increases still leave the cost of borrowing such funds at well under ten percent; you will have a hard time doing better elsewhere. Have you checked the cost of a credit card loan lately?

If you simply want to pay off the money at the lowest cost available, you might want to exchange the line of credit for a fixed-rate home equity loan. You will lose the “use it whenever you want” flexibility of your credit line, but you will exchange it for a fixed debt that you can repay on a fixed schedule. If the amount of money involved is large, then this may be a better choice for you.

For many people, the flexibility of the line of credit, not the prevailing interest rate, is what makes the tool useful. If that is the case, then you should not worry too much about rising interest rates. They are, historically speaking, quite low even now.