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5 ways to tame your line of credit

By Holden Lewis • Bankrate.com   
 

Lots of consumers have watched the rates double on their home equity lines of credit in two years.

Say you took out a credit line at the prime rate two years ago and borrowed $30,000 against it. Back then, you
faced a monthly payment of $100. Now that same loan at the prime rate costs $206 per month.

That's even more dramatic than the rise in gasoline prices.

If you have a home equity line of credit, or HELOC, you have at least five options.

 
5 options for a HELOC: 
 
 
1.  Keep the credit line and pay down the balance.
2.  Keep the credit line and grin and bear the higher interest rate.
3.  Pay off the line of credit with a fixed-rate home equity loan.
4.  Get a hybrid credit line with a fixed-rate option.
5.  Pay off the credit line by doing a cash-out refinance of the primary mortgage.
 

1. Keeping it
Dennis Grundler of Henderson, Nev., chose the first option. He manages his debts like a corporate chief financial
officer, always seeking the best deal. Not counting his mortgage, he has about $67,000 in debts. He could put all
of it on his credit line at the prime rate, but most of the debt is spread on various credit cards with
introductory rates of zero percent, 1.99 percent or 4.99 percent. The home equity line of credit has a balance of
just $12,500, and he says he more than quadruples his minimum monthly payment of about $86. At that pace, he can
pay it off in less than three years.

"I am keeping the HELOC because it gives me added flexibility in terms of cash flow," he says. He originally took
the line of credit to pay for a pool.

A lot of us don't have the discipline or income to pay down the balance on a credit line, so we have to weigh the
pros and cons of the other options.

"The primary decision is between fixed and variable rate," says Simon Griffiths, a home equity executive with
Washington Mutual. Home equity lines of credit have variable rates and home equity loans have fixed rates.

2. Keep it and bear it
A lot of those people will do nothing about their credit line, either deliberately or because they just won't get
around to making a change. They keep the credit line, resolving to grin and bear the higher rate. After all, the
pain probably won't get much worse. Economists and investors believe that the Federal Reserve has almost finished
raising interest rates.

Understanding lines of credit
Credit lines work like credit cards: The homeowner can borrow, then pay some or all of the principal, then borrow
again. For a few years, the borrower has to pay only the interest on the outstanding balance.
Rates on home equity lines of credit go up and down with the prime rate. Responding to the Federal Reserve's rate
moves, the prime rate has been raised 17 times since June 30, 2004, and the Fed might have another hike or two to
go.

Fixed-rate home equity loans come as a lump sum, and the monthly payments include principal and interest so that
the balance will be paid off over a set period. The monthly payments don't change.

 

Two years ago, the average rate on a HELOC was lower than on a home equity loan. Now it's the other way around. But
a lot of people keep their credit lines for the same reason Grundler does: It gives them flexibility. They can pay
only the interest or they can make more than the minimum monthly payment and reduce the principal.

3. Home equity loan option
For folks who want to pay down that principal every month, refinancing into a home equity loan is an increasingly
popular option. "For the most part, what you see is people paying off their line of credit with a fixed-rate,
closed-end second mortgage," says Bob Walters, senior vice president of Quicken Loans.

He says about seven in 10 new second mortgages is a home equity loan, whereas a year ago it was one in 10.

Because of the requirement to pay principal, not everyone is ready for the rigor of a home equity loan. If you have
a balance of $25,000 on a home equity line of credit with a rate of 8.25 percent, the interest-only payment is
$171.88 a month. If you owe the same amount on a home equity loan with a rate of 7.75 percent and a repayment
period of 15 years, the monthly payment is $235.32.

4. The hybrid option
A few lenders, including Bank of America, Washington Mutual and Wells Fargo, offer hybrid credit lines that allow
the borrower to set a fixed rate on some or all of a HELOC's balance. Each bank does it differently, but the
concept is the same: "It's a home equity loan within a home equity line of credit," says David Rupp, a home equity
executive with Bank of America.

Ed Yu of Los Gatos, Calif., twice has taken advantage of this hybrid feature of his Wells Fargo EquityLine with
FlexAbility account. He bought cars: $23,000 at 7.5 percent to be paid off in five years, and $33,000 at 8.25
percent to be paid off in10 years. "I anticipate paying these down early (or at least have high hopes to!), but we
fixed the rate to ensure that we are still comfortable with our cumulative monthly payments/cash outflows," he says
in an e-mail.

Having used $56,000 of the $222,000 credit line, Yu and his wife have more than $150,000 available for borrowing.
They're holding it in reserve, but a lot of people in the Yus' position would spend it.

"An emerging, strong use of the product is to purchase vacation or second homes, in addition to the usual home
improvement, education and debt consolidation uses," says Lisa Benoit, Washington Mutual executive.

But some use WaMu's hybrid HELOC to consolidate and pay down their debt. Marie Anderson of Moreno Valley, Calif.,
converted almost all of her HELOC into a fixed-rate loan. She says she had a $65,000 credit line with Countrywide
that started out last fall with an introductory rate of 6.3 percent. Then the rate started rising, and hit 12.75
percent in June.

Anderson refinanced in early July by getting a $74,000 line of credit with Washington Mutual. She fixed the rate on
the $65,000 balance at 8.4 percent for five years. She can pay interest only, but Anderson says she's going to pay
down principal. As for the roughly $9,000 remaining on her credit line: She says she doesn't plan to borrow against
it.

5. Cash-out refi
The final way to lower the rate on a credit line is to do a cash-out refinance of the primary mortgage. Here's how
it works: You have a $200,000 primary mortgage and a $30,000 on a credit line. You refinance the primary mortgage
for $230,000. That gives you $30,000 cash, which you use to pay off the credit line.

Bankers and researchers say the cash-out refi isn't as popular as it was last year because mortgage rates have gone
up. Plenty of homeowners have primary mortgages with rates of 6 percent or lower. Now the average rate on a 30-year
fixed is north of 6.75 percent, and homeowners are understandably reluctant to refinance at a higher rate.

But they should at least run the numbers, especially if the balance on the credit line is large, says Anthony
Hsieh, president of LendingTree.

For example, if you have a $200,000 primary mortgage at 6 percent, and a $150,000 line of credit at 8.25 percent,
the minimum monthly payments are about $2,230. That's making interest-only payments on the line of credit. If you
refinanced the entire amount with a 30-year loan at 6.75 percent, the monthly principal and interest would be
$2,270. For $40 per month more, you're paying principal on the entire $350,000.

Sometimes it makes sense to refinance at a higher rate. "That sounds completely opposite what a refinance is
supposed to do," Hsieh acknowledges. And that's why it's best to look at all the options.

Pitfalls
There are pitfalls to look out for. Hsieh says a cash-out refi might not be feasible if your total mortgage and
home equity debt is greater than 90 percent of the home's value. And the higher the loan-to-value ratio, the higher
the mortgage rate.

A cash-out refi costs thousands of dollars in fees, whereas home equity loans and lines of credit have much smaller
fees.

"It's a real careful consideration," says Steve Habetz, president of ARCServ, a network of real estate attorneys
who help home buyers find real estate agents and lenders. "The biggest concern that we have at ARCServ is there are
so many sales pitches out there."

Sometimes, Habetz says, "the best advice is to do nothing."

Nothing, that is, but keep making timely payments on that credit line.

Source:http://www.bankrate.com/brm/news/loan/20060713a1.asp?caret=6