Home Equity Loans in a Rising Interest-Rate Environment

If you're a homeowner looking to tap the equity in your home, a cash-out refinance of a 15- or 30- year fixed rate mortgage is generally a first choice. While you'll incur more long-term interest rate charges, you'll also enjoy the benefit of lower monthly payments.

However, during periods of rising interest rates, a cash-out refinance doesn't always look desirable. If you have a terrific rate on your first mortgage, a mortgage refinance would mean that you'd change it in for a higher rate. That choice isn't tempting to most financially responsible homeowners.

Tapping equity

It's a catch-22 if you've seen the value of your house skyrocket during the last several years. With a boosted property value, you now have plenty of equity to tap for such big-ticket items like home improvements or school tuition payments. Unfortunately, the rise in interest rates has tied your hands.

The solution would be to choose a home equity loan or a home equity line of credit. This could make a nice short-term solution for cash needs, and if you pay it off sooner than later, it could stand to help you in the long run. Here's why:

Advantages of home equity loans

Smaller terms, less interest paid. Whether you choose a home equity line of credit, which works like a credit card with an adjustable limit, or a home equity loan, which has a fixed-rate and fixed term, you can generally pay off this smaller loan faster than you would a mortgage. This can help you get through a short-term cash crunch without sacrificing long-term interest dollars.

Easy to close, low fees. Unlike a cash-out refinancing, a home equity line of credit or loan can be closed rather quickly with minimal documentation and low fees. More often than not, your lending institution can use the appraisal from your previous mortgage loan, thereby saving you extra money.

The option to roll it into a first mortgage down the road. Don't forget Newton's law of interest rates: what goes up, must come down. If fixed-rates on 15- or 30- year mortgages drop in the future, you can always refinance that first mortgage and pay off your home equity loan.

There are plenty of options for homeowners in the face of rising interest rates. While the cash-out refinance might not be one of them, a flexible home equity line of credit or a fixed-rate home equity loan might be the best way to tap equity without costing you additional money long-term.