April 28, 2017, 11:38 AM

If You Have a HELOC, Look Out for Rising Interest Rates

By Michael Gibney, CFP®, AIF®

A home equity line of credit (HELOC), sometimes referred to as a second mortgage, has become more popular as the economy has improved because it can be used to pay for home additions, buy a car or maybe fund a child’s education.  HELOCs are available to those who have enough equity in their home to use as collateral for securing the loan.

In a nutshell, a HELOC works similarly to a credit card - you only pay interest when you borrow against the line, and when you pay it back, you restore the initial amount you were approved to borrow.

The interest rate on a HELOC is generally variable, unlike the fixed rates of traditional mortgages.  This means that the interest rate will increase or decrease based on the benchmark used.  Most banks use the Prime Rate published in the Wall Street Journal or other publications as the benchmark.  The borrower’s rate is set using either the rate itself or a margin above or below the Prime Rate.  For example, your loan may have a rate noted as Prime minus 0.50%, which as of this writing means your current rate is 3.50% (Prime is currently 4.0%). 

Consequently, again unlike fixed mortgages, your payment towards the line of credit will fluctuate up or down depending on which direction the rate changes, which can make budgeting a little more onerous.

Recently, this has not been a concern.  In fact, the variable rate has been beneficial because until last year, rates had decreased or remained low for long periods.  Going forward however, this may change.  We have seen an increase in the Prime Rate twice since December 2015, and consensus thinking tells us to expect another two or three increases in the next year or so.

So, what does this mean for those of us who have an outstanding balance on our HELOC?  Obviously, the amount we owe will increase as rates rise because we are paying a higher interest rate on the balance.

Let’s look at an example using round numbers to keep the illustration simple:  someone who owes $100,000 at rate of 3.5%, will incur $3,500 per year in interest, and when the rate increases to 4%, the amount they owe in that year will increase to $4,000.  When the rate increases to 4.5%, the amount owed is now $4,500, or ~$83 more per month.  Depending on how much you owe, this amount may have either very little or a significant impact on your monthly budget.

Adding another wrinkle, many HELOCs “allow” the owner to pay interest only.  So, you can “get away” with paying very little per month.  Even if the interest rate increases, you are still paying only the interest, which could be very low.  However, those paying interest only risk increased payments if the rate is raised substantially higher over the term of their HELOC.  This issue may rear its ugly head quickly because the typical HELOC has a duration of only 10 years. 

This had not been an issue in a falling interest rate environment because of the option to refinance a HELOC—a relatively easy process as long as you have good credit and steady income.  However, as rates increase, refinancing may not be an appealing option because it may end up being an expensive one.

 

Disclosure: Modera Wealth Management, LLC (“Modera”) is an SEC registered investment adviser with places of business in Massachusetts, New Jersey, Florida and Georgia. SEC registration does not imply any level of skill or training. Modera may only transact business in those states in which it is notice filed or qualifies for an exemption or exclusion from notice filing requirements. For information pertaining to Modera’s registration status, its fees and services and/or a copy of our Form ADV disclosure statement, please contact Modera or refer to the Investment Adviser Public Disclosure web site (www.adviserinfo.sec.gov). A full description of the firm’s business operations and service offerings is contained in our Disclosure Brochure which appears as Part 2A of Form ADV. Please read the Disclosure Brochure carefully before you invest or send money.

This article contains content that is not suitable for everyone and is limited to the dissemination of general information pertaining to Modera’s investment advisory and financial planning services and general economic and market conditions. Nothing contained herein should be interpreted as legal, tax or accounting advice, nor should it be construed as personalized investment, financial planning or tax planning advice. For legal, tax and accounting-related matters, we recommend that you seek the advice of a qualified lawyer or accountant. Past performance is no guarantee of future results, and there is no guarantee that the views and opinions expressed herein will come to pass. This document contains forward-looking statements that use words such as "anticipates," "projects," "believes,” and/or "expects," that indicate future possibilities. Due to known and unknown risks, other uncertainties and factors, actual results may differ materially from the expectations portrayed in such forward-looking statements. Readers are cautioned not to place undue reliance on forward looking statements, which speak only as of the date of this document. Investing in the stock and other markets involves gains and losses and may not be suitable for all investors. Information presented herein was accurate at the time of publication, is subject to change without notice and should not be construed as a solicitation to buy or sell any security or to engage in a particular investment, financial planning, tax or other strategy. Diversification does not guarantee a profit or guarantee against a loss.

 

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April 13, 2017, 5:45 AM

Business Owners: SEP versus 401(k)?

By Michael Gibney, CFP®, AIF® and Karl Graf, CPA/PFS, CFP®

Self-employed business owners may not be aware of their options for establishing and funding a retirement plan. As we all know, one of the benefits of working for a large company is that most employers offer an opportunity for employees to contribute a relatively high amount to a retirement plan...

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