The once cherished Home Equity Loan, referred to in the mortgage industry as a HELOC (Home Equity Line of Credit), suffered a major blow with passage of the tax reform act last month. For tax year 2018 and beyond, interest paid on these loans is no longer tax deductible.

To make matters worse, virtually all HELOC’s have adjustable rates. These adjustable rates are directly tied to the action the Federal Reserve takes on monetary policy. When the Fed raises what’s called the Federal Funds Rate, it affects the Prime Lending Rate. The Federal Funds rate is the rate banks are charged when they borrow money. The prime rate is the index most Home Equity loans are tied to when determining the rate the borrower must pay. When it costs the banks more to borrow, they have to increase the rates they charge their customers. The Prime Lending rate is pegged at being 3% above the Federal Funds Rate. The current Federal Funds rate is 1.500% and the Prime is at 4.500%.

It is widely expected that the Fed will increase interest rates 3 times this year. Typically each time the Fed raises rates, they hike it by a quarter percent (0.250%). Those collective rate hikes would mean your Home Equity rates will raise 0.750% this year. That would put the prime rate 5.250%.

But don’t stop there. Most HELOC’s while tied to the prime rate do not adjust to the prime rate. Depending on the terms when you first got your loan, you may pay anywhere from ½% to 2% above the prime rate. For some, they could see a 7.000% rate by the end of 2018.

While rates are still below 4% for a 30-Year Fixed rate 1st mortgage, there’s no better time to get rid of that HELOC than now.

If you are wondering what affect the new tax laws have on deductibility of interest on 1st mortgages, mortgage interest on the first $750,000 is still fully deductible. For all that was made in the news about it, under the old rules, we were capped at $1,000,000. Even with Hawaii’s high home prices, most homeowners in our state will not experience a change in what they can deduct. It is important to note that the reduction from $1,000,000 to $750,000 is on new mortgages obtained in 2018 going forward. It does not affect older mortgages where the old limit of $1,000,000 is still allowed.

HELOC’s are still an important tool to allow homeowners easy access to the equity in their home. But the way HELOC’s have been used in recent years goes against what they were designed for. HELOC’s were designed to allow short-term access to your equity. Many buyers used a HELOC to put less than 20% down to avoid mortgage insurance. Many used a HELOC to buy toys – be it cars, boats, or travel. All these uses put your equjity at risk because as stated above, most HELOC’s are adjustable rate products. Having a HELOC is fine. It is there for emergencies and temporary use. Keeping a large balance is not the best financial move right now.

While we have enjoyed years of relatively low stable interest rates, that situation is changing. It was not a very long time ago when HELOC 2nd mortgages were in the range of 9%-12%. The good news is that fixed rates are still near record lows. Take advantage of this friendly advice and current conditions. If you have a large balance on a HELOC and cannot pay it off within the next 3-5 years, you should refinance and move that balance to your 1st mortgage.

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