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The latest wrinkle in refis
Some banks are offering a new way to refinance: a home-equity line of credit. Should you try it?
September 25, 2003: 3:47 PM EDT
By Jean Sherman Chatzky, Money Magazine

NEW YORK (Money Magazine) - When customers approach a lending officer at Pittsburgh-based PNC Bank to refinance their mortgage, they're offered a menu of choices. One of them is not a refi at all.

At PNC -- and, we hear, at many other banks all across the country -- homeowners are being encouraged to take out a home-equity line of credit (HELOC) and use that stream of cash to pay off their first loan. That's one reason that outstanding HELOC debt has climbed from $163 billion in 1999 to $359 billion in 2002.

It sounds like a tempting offer.

According to, which publishes mortgage-rate information, 15-year fixed-rate loans are now going for 5 percent. You can get a HELOC at prime, currently 4.25 percent, in just about any market in the United States.

Moreover, on a refi you'd pay an average of half a point -- or 0.5 percent of the amount of the loan -- in closing costs and another half a point in legal fees and appraisals. Closing a HELOC at PNC runs just $21.

"It makes sense," says Mike Moll, director of marketing at PNC. He not only swapped his own 6.875 percent, 30-year fixed-rate mortgage for a HELOC at 4.25 percent but also sold his brother and brother-in-law the same deal.

Pros & Cons of HELOCS
Taking out a home equity line of credit might be better than a refi.
ProClosing CostsThe average fixed-rate refi adds a closing fee of 0.5 percent to the cost of the mortgage. A HELOC costs as little as $20.
ProInterest RatesMortgages now hover in the mid-5-percent range. A HELOC is typically written at the prime rate, 4.25 percent lately.
ConInterest RatesIf interest rates rise quickly, your prime rate HELOC will jump. A fixed-rate mortgage is better insulated against this shock.
ConEaseHELOCs require active maintenance -- watching interest rates like a hawk. A good refi is "set it and forget it."

Is Moll right? He's definitely onto something, says George Yacik of SMR Research, which maintains data on the HELOC market.

"For people who have $90,000 in mortgage debt and a $1,000,000 credit line," Yacik notes, "writing themselves a check is equivalent to a quick refi -- a free refi."

But even if it's fast and cheap, it may not be smart. The reason: A HELOC is an adjustable-rate loan.

"The question you need to ask yourself is, why would a bank be pitching you this product at this time?" says HSH's Keith Gumbinger. "The obvious answer is that bankers believe rates will rise in the future. Getting you out of a fixed loan and into a variable one helps ensure profitability on your account."

Moreover, he notes, when rates rise, they can do so very quickly. The period of interest-rate hikes we experienced beginning in 1998 saw rates rise two points over a year and a half. A jump like that would make today's 5 percent fixed-rate mortgage look downright cheap.

Different scenarios

So what sort of customers does a home-equity arbitrage like this make sense for? Gumbinger ran some scenarios to see. Here's one.

Let's assume you bought a home 10 years ago, taking out a $300,000, 15-year fixed-rate loan at 7 percent, and you've never refinanced. Your monthly payment on that loan is $2,696. Today you have an outstanding balance of $136,200, of which $26,000 is interest.

Refinance the balance into a new 15-year mortgage at 4.98 percent, and your monthly payment slides precipitously to $1,075. But if you take the full 15-year period to repay the loan, you end up more than doubling the total interest you pay, to $56,000.

What if you instead take the HELOC with a 20-year term at 4.25 percent? If rates stay low, you're golden. But if they rise 1 percent a year until they hit 7.5 percent -- the average prime rate over the past decade -- your monthly payment climbs from $843 in the first year to $1,073 in years five through 20. Over the 20 years, the interest will total $114,000.

There is a way to save real money in this situation: prepay like crazy.

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If you continue to pay at your old rate on the new 15-year mortgage, you get out in 56 months and save roughly $6,500, after $2,600 in closing costs. If you opt for a HELOC instead -- assuming you get one with no prepayment penalties -- the absence of closing costs and the lower starting rate would about double your savings, even if rates go up 1 percent each year.

Is it worth it? It may well be -- but only if you have the stick-to-itiveness to watch rates like a hawk and quickly lock in a new fixed-rate loan if they start to rise. PNC's Moll thinks he can do that. Then again, he works in a bank.

Editor-at-large Jean Chatzky appears regularly on NBC's Today. Contact her by e-mail at  Top of page

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