How Does a Fixed-Rate HELOC Work?

A home equity line of credit, also known as a HELOC, is a financial product that allows you to tap into the equity in your home. There are typically no limits on how you can use this money, making it an attractive option for many homeowners. While HELOCs typically have variable rates that change over time, it is sometimes possible to secure a fixed-rate HELOC. Learn how fixed-rate HELOCS work and some other options you may want to consider.

What Is a Fixed-Rate HELOC?

A fixed-rate HELOC is a home equity line of credit with an interest rate that does not change. This product allows you to borrow against the equity in your home. Instead of taking out a lump sum, you can make multiple draws from your HELOC throughout a preset draw period. 

There are no restrictions on how a HELOC may be used, so homeowners may take out fixed-rate HELOCs for purposes such as:

• Debt consolidation
• Home improvement projects
• Tuition or education costs
• New business ventures
• Emergency expenses

Unlike a typical variable-rate HELOC, the fixed-rate option offers a stable monthly payment amount throughout your repayment period. 

How Does a Fixed-Rate HELOC Work?

A fixed-rate HELOC works in much the same way as a variable-rate HELOC. It begins with a set draw period, which is the time when you’re able to access the funds. During the draw period, you can make withdrawals as you need them up to the maximum amount. Some lenders also allow you to make interest-only payments during the draw period.

Once the draw period ends, you enter the repayment period and must start making both interest and principal payments. Your minimum monthly payment is based on:

• Your outstanding balance
• The time remaining to pay
• Your interest rate

Once it’s calculated, the minimum monthly payment remains the same throughout the repayment period.

Maximum Withdrawals

The maximum amount of cash you can access depends on the amount of equity you have in your home and the lender’s guidelines. While some lenders have higher or lower limits, many lenders allow you to borrow up to 85% of the value of the home, minus what you owe on your primary mortgage. 

For example, assume your home is worth $500,000, and you owe $200,000 on your current mortgage. In this case, you may be able to borrow 85% of $500,000 ($425,000) minus $200,000, or $225,000 in total.

Loan Terms and Periods

HELOCs typically have loan terms of 5 to 30 years. The draw period may last as long as 10 years, and the repayment period continues until the end of the loan term. A variable-rate HELOC has multiple repayment periods with different interest rates and minimum payment amounts. However, the rate and minimum payment of a fixed-rate HELOC remain the same throughout the repayment period.

Continuing with the example in the previous section, assume you took out a 30-year fixed-rate HELOC with a 4.5% interest rate and a 10-year draw period. During the draw period, you could take out a single withdrawal or multiple withdrawals up to a total maximum of $225,000. When the repayment period begins, you can no longer draw from your HELOC and must begin making minimum payments that include both principal and interest. The minimum payment amount is based on the outstanding balance at the end of the draw period, amortized over the remaining 20 years at a 4.5% interest rate.

Advantages of a Fixed-Rate HELOC for Your Mortgage

There are several advantages to choosing a fixed-rate HELOC. Here are some of the ways locking in the rate on your HELOC could be beneficial:

• Predictability: Fixed-rate HELOCs have a fixed payment, which can make it easier to budget. Many homeowners also appreciate not having the uncertainty that can come with a variable-rate loan.
• Inflation protection: Variable-rate loan payments can increase significantly when rates start to rise. By locking in your rate, you’re immune to these fluctuations.
• Flexibility: Some lenders allow you to convert fixed-rate HELOCs to a variable-rate option if rates start to drop, giving you additional flexibility.
• Potential cost savings: When you take out a HELOC, you only pay for the amount you actually draw rather than the entire balance. This could help you save money on interest payments.

Disadvantages of a Fixed-Rate HELOC for Your Mortgage

While fixed-rate HELOCs offer some advantages, they are not right for everyone. Before taking out this type of loan, consider these potential drawbacks:

• Fees: Fixed-rate HELOCs may include annual fees, rate-lock fees, and other fees which can increase the overall loan expense.
• Minimum borrowing requirements: Your lender may require you to borrow a minimum amount to be eligible for a fixed-rate option.
• Potentially higher interest rates: The interest rate on a fixed-rate HELOC is typically higher than the introductory rate on a variable-rate HELOC. If interest rates go down, you may also be locked into a rate that is higher than the current market rate.

Fixed-Rate HELOC vs. Variable-rate HELOCs

When deciding whether to choose a fixed-rate or variable-rate HELOC, it’s important to consider both market conditions and your specific needs. For example, if you expect inflation or interest rates to rise, you may consider locking in the current rates with a fixed-rate HELOC. However, if you think interest rates are poised to fall, a variable-rate HELOC may allow you to take advantage of these fluctuations.

Fixed-rate HELOCs have predictable minimum monthly payments, which can give you structure and help you stay on budget. When planning remodeling and home-improvement projects, locking in a fixed rate can allow you to take your time without worrying about trying to finish the job before rates rise. On the other hand, if you want to make smaller draws, a variable-rate HELOC may be a good choice since they typically do not have minimum draw amounts.

Can You Convert Your Fixed-Rate HELOC to Another HELOC?

Some fixed-rate HELOCs are hybrid products that allow you to convert all or some of your outstanding balance to a variable rate at the end of your draw period. This varies by lender and may not be available for your particular loan. There’s also a chance that the lender may charge a fee to make this conversion.

If a conversion is not available, you may also be able to refinance your current fixed-rate HELOC into a new variable-rate HELOC. In this case, you may need to go through the application and approval process again, and there may be additional costs involved in originating a new loan.

Can You Convert Your Current HELOC to a Fixed-Rate HELOC?

Some lenders allow you to transfer all or a portion of your current variable-rate HELOC balance to a fixed-rate option. You may be able to request a conversion during the draw period or after your repayment period begins. This may be a good idea if you believe interest rates are going to rise in the future.

While converting your HELOC balance may give you a lower interest rate, there may be some fees involved. Lenders typically charge a transfer or rate-lock fee each time you lock in a rate. Many HELOCs allow borrowers to lock in rates multiple times with a portion of their outstanding balance. However, you may end up paying a new fee each time you do so.

How to Get a Fixed-Rate HELOC

Eligibility requirements for HELOCs can vary among lenders. Your lender may set requirements for the maximum loan-to-value (LTV) ratio, which is the balance of your outstanding mortgage in relation to the appraised value of the property. Other requirements typically include having a minimum amount of home equity, adequate property insurance, a reliable payment history, sufficient income, and a minimum credit score.

Some lenders may accept HELOC applications online while others may require you to visit a branch to sign your paperwork and provide the necessary documentation. Approval times also vary and may range from a couple of weeks to a few months. HELOCs may also have closing costs, annual fees, and other fees.

Other Options to Consider

If you’re looking for a way to tap into your home equity and you’re not sure a fixed-rate HELOC is right for you, there are a few other options to consider.

Fixed-Rate HELOCs vs. Cash-Out Refinancing

A cash-out refinance allows you to lock in a new interest rate and loan terms by refinancing your primary mortgage. You can access the equity in your home by taking out a new mortgage for more than what you currently owe. The new mortgage will pay off your previous mortgage balance and you would take out the extra amount to spend as you see fit.

This can be a good option if current rates are lower than the rate you’re paying on your mortgage and you want to borrow a lump sum of money.

Fixed-Rate HELOCs vs. Home Equity Loans

A home equity loan is similar to a fixed-rate mortgage. It allows you to take out a lump sum of money and make fixed payments over the lifetime of the loan, which can be 20 years or longer. This may be advantageous if you know how much you need to borrow and how long you want to take to pay it back. If rates drop during repayment, you can refinance your loan to lock in a new, lower rate. However, this also comes with additional closing costs.

Fixed-Rate HELOCs vs. Personal Loans  

A personal loan allows you to access a lump sum of cash without using your home as collateral. These loans may process faster than a HELOC, giving you access to funds sooner. Personal loans may have either a fixed or variable rate and typically have repayment periods of 1 to 5 years. This may be advantageous if you’re taking out a small amount, since having less time to repay the loan equates to higher minimum payments.