Q: I have secured a variable rate home equity line of credit with the option to convert to a fixed rate. At the present time the variable rate is 5.25 percent. If I convert the loan to a fixed interest rate, the rate will be anywhere from 6.78 percent to 7.78 percent.
Should I have chosen a fixed rate in the first place? What are the pro and cons of a variable rate? What are the pros and cons of a higher percentage fixed rate?
A: The benefit of a fixed-rate interest loan is that you know how much you will pay every month throughout the life of the loan. For some homeowners, knowing that the payment will never change — no matter how much they earn each month — is worth paying for.
A variable rate loan means that the interest rate will fluctuate over time. Sometimes it will go down and other times it will go up. If you’re comfortable with not knowing exactly what your payment will be, but knowing there are some safeguards in place with respect to how much the rate can rise or fall in a single year, then your increased risk tolerance is rewarded with a lower interest rate.
If you need the security of knowing what the payment will always be, you need to get a fixed-rate loan. But prepare to pay a lot for that security. You’re paying 5.25 percent for your variable rate loan. A fixed rate would be 1.5 to 2.5 percent higher.
I think that’s a bit steep. You’re better off keeping the variable rate loan and working hard to pay off your home equity line of credit as quickly as possible. Paying it off will ultimately limit how much interest you’ll pay on the loan because you’ll pay off the line of credit sooner.
Published: Sep 3, 2004