Thinking long-term as variable rates rise?
More owners play it safe by refinancing into
30-year fixed loans.

October 9, 2005

HOMEOWNERS who borrowed against the rising value of their homes in the last few years are paying for it now. Since June 2004, the Federal Reserve has raised short-term rates 11 times, driving the prime-rate benchmark for adjustable home-equity loans from 4.25% to 6.75%, its highest level in four years. And another hike could be ahead before the year is out.

The Fed's measures have succeeded in keeping inflation at bay, but have left borrowers such as Sunday Rodriguez scrambling for an exit. Rodriguez, a senior manager at a Los Angeles business management firm, found a solution that is fast becoming popular in Southern California — rolling her equity line into a new fixed mortgage that locks in today's low interest rates.

"I was sitting back watching the interest rates going up and up and I thought, 'My gosh, this is just going to kill me,' " said Rodriguez, who took out a 4.25% home-equity credit line on her Ladera Heights duplex in late 2003, when short-term rates looked relatively stable.

The 48-year-old mother of two had used the money for two new cars, kitchen renovations, investment in a family business and to help her oldest daughter through law school. She quickly ran up $155,000 in debt.

Although her interest-only payments were doing nothing to reduce the principal, Rodriguez figured that her home's double-digit rate of appreciation would bail her out if she had trouble repaying the loan. The situation worsened when interest rates on the equity line began to rise.

By August, the rate on her credit-line borrowing stood at 6.5%, making her monthly payment nearly $900 — up from about $600 a year earlier. Add that to her $2,200-a-month fixed-rate mortgage, which hadn't been affected by the Fed's moves, and Rodriguez was on the hook for $3,100 a month.

So she decided to stop waiting for Federal Reserve Chairman Alan Greenspan to have a change of heart. Like thousands of other Southlanders who've seen the interest-rate writing on the wall, Rodriguez rolled her equity line and her first mortgage into a new, 5.75% fixed-rate 30-year loan for $550,000, saving $500 a month on payments and turning an uncertain future into a secure one.

"Now, instead of worrying about how I'm ever going to pay off $155,000, when all I'm paying is interest, I'm planning on having my mortgage close to being paid off when I'm" retired, Rodriguez said.

Thanks to an unusual combination of a strong bond market and the Fed's inflation-prevention measures, long-term rates are holding steady at historic lows while short-term rates rise.

"This is one of the first times we've experienced long-term rates not moving at the same pace as short-term rates," said Karen Crosby, a mortgage broker with Sherman Oaks-based Metrocities Mortgage. "What we're seeing is it's an opportune time for people who are overextended to bail themselves out."

The number of homeowners seeking to refinance their equity lines into new fixed-rate mortgages has risen significantly, several area mortgage brokerage firms report, although none tracks that data. Allen Bond, president of Palos Verdes Funding Group, said the calls started pouring in after short-term rates hit 6% in January.

"I think most people recognize that the short-term rates are going to continue to rise and fixed rates are still pretty darn good," said Bond, who is also a director of the California Assn. of Mortgage Brokers. "They want to lock in some security."

Deciding whether it makes sense to roll an equity line into a fixed-rate mortgage isn't always easy. A borrower with no plans to move, for instance, would clearly benefit from the lower interest rate that comes with a fixed mortgage. Not only would total monthly payments likely drop, but the owner would also end up paying less for the home in the long run.

On the other hand, someone planning to move in the next three or four years might not benefit from the change. Refinancing fees would likely cancel any benefit from the lower rates because it would take longer than three years to recoup those loan costs.

Another caveat: If the original mortgage has a particularly low interest rate, it may be unwise to seek a refinance that would lower the rate on the home-equity line but raise the overall rate.

Ted Grose, chief operating officer of All Nationwide Funding Group in Los Angeles, said this situation is common among homeowners who took out their first mortgages in 2003, when long-term loan rates were at their lowest.

"I know people who have 30-year fixed rates under 4.75%" said Grose. "You'd have to have a rate on that equity line that was really, really high to provide any kind of incentive to get rid of that underlying first [mortgage]."

Rules are sometimes made to be broken, however. Jason and Arsha Reitz refinanced $100,000 of equity-line debt on their $1.4-million Carthay Circle home in September, trading their $700,000, 3.37% three-year fixed mortgage for a 30-year mortgage fixed at 5.75%.

"We lost out on our low-rate first, but we figure rates will be higher than this in 2007, when that three-year fixed would have run out," said Jason Reitz, a real estate agent who used much of the equity loan to add a pool, cabana, basketball court and other improvements to the home's backyard. "And 5.75% is a ridiculously low, once-in-a-lifetime rate for a 30-year fixed mortgage."

Like many homeowners, the Reitzes have refinanced before. Two years ago, they rolled an earlier home-equity credit line of $70,000 into a new mortgage — the one they refinanced in September — expecting to sell before the three-year loan was up. But they instead decided to heed the warnings of their parents.

"We've heard too many stories from our parents — 'Oh, I wish we'd never sold this, I wish we'd never sold that,' " Jason Reitz said. "So, we're parked here for the long term."

Spooked by rising short-term interest rates and talk of a housing bubble, increasing numbers of Southland homeowners appear to be following the Reitzes' cautious approach, Grose said.

"You can see it in … all the home improvements," Grose said. "People are digging in for the long term. And approaching the refinance of an equity line from that perspective, in the framework of 'What is the most conservative approach for a 10- or 15-year plan?' makes the decision a little easier."

Brokers caution homeowners trading an equity line for a fixed-rate mortgage not to forget the lessons they've learned — many who refinance end up taking out yet another line of credit. The Reitzes did so, insisting they will use their line only as a last resort. Rodriguez, on the other hand, listened to her broker Karen Crosby, who has a standard bit of advice for clients in her situation.

"I tell them, although they're the ones that keep me in business, I don't want to see them back here next year with a $100,000 balance again, having used up all their equity buying boats and SUVs and redoing their home and putting in a pool," she said. "They need to be responsible about using it."

Although Rodriguez could have sought a new credit line of up to $235,000, she limited herself to a $20,000 cash-out on her refinanced mortgage. And that went into a secured account for her second daughter, who'll be a college freshman next year.

"I probably have a good 15 years of work left in me," Rodriguez said. "I like my home, and my goal is to do it the old-fashioned way — by paying down the principal."