The connection may not be obvious, but when inflation in China and other foreign countries begins to kick up, prices may start to rise in the West as well. In fact, many economists have expected inflation to rise in the U.S., they just haven’t been able to say when.
Now that the U.S. economy is showing real signs of strengthening, the Federal Reserve is more likely to start raising short-term interest rates to prevent inflation from getting a foothold. That could cause the prime rate to rise from its current level of 3.25%, and that would push up rates on HELOCs that are tied to the prime rate.
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Some experts believe that HELOCs, now charging a bit more than 4%, could be charging nearly twice as much in a year or two. Anyone sitting on a big HELOC balance could face a jump in payments.
Paying down debt is almost always a good strategy, but a borrower might not consider a HELOC a top priority, especially if other debts, like credit cards, charge higher rates. While it generally pays to tackle the debt with the highest rates first, it makes sense to look at a HELOC in terms of what it could charge in the future, rather than what it charges today.
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Even with interest rates likely to rise, home equity loans remain an attractive source of cash for homeowners with sufficient equity – which is the home’s value minus any current debt, such as a mortgage. Unlike the HELOC, the home equity installment loan carries an interest rate that is fixed for the life of the loan typically 36 to 120 months.
There is a downside, though: Installment loans charge higher rates, currently from about 6.3% for a 36-month loan to 7.5% for a 10-year loan, according to the BankingMyWay.com survey. While a HELOC is a good deal cheaper today than before the recession, it could be more expensive over the long run if interest rates rise as expected. An installment loan may be a better choice for anyone looking to borrow a large amount for a long period.
For now, a HELOC would be the best choice only under two conditions: It might pay if you expect to borrow for only a short period or have resources to pay the loan off quickly if rates spike. A HELOC can also serve well as a rainy day fund. That way, you will carry no debt unless you face an emergency. If a serious need does occur, a HELOC will be cheaper than a credit card, even if rates do rise.
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