Banks sweeten home equity deals; Rising interest rates are spurring moves to win customers.

Rising interest rates finally are slowing the growth of home equity borrowing.

In response, lenders are rolling out inducements to attract new borrowers and keep existing homeowners from paying off their loans.

U.S. Bank, a unit of U.S. Bancorp, this week introduced a home equity loan with a rate of 5.99 percent that is fixed for 20 years. Previously, the bank's rate in most markets was 6.99 percent or higher.

Other banks are offering enticements to keep customers who are worried about rising rates from paying off their home equity lines of credit.

Wachovia Corp.'s "win back" program is offering 1 percent below the prime interest rate to certain borrowers who previously paid off their home equity lines or seem likely to. Wells Fargo & Co. began a program in August that gives existing customers the option of continuing to make interest-only payments on their home equity lines of credit, while setting a fixed rate on some or all of the balance.

Home equity lending has boomed in recent years as record numbers of Americans have taken advantage of low rates and rising home values to finance their spending needs or pay off high-cost debt. Borrowing against home values added $600 billion to consumers' spending power last year, according to Federal Reserve calculations, with about one-third of that sum coming from home equity loans and lines of credit.

Home equity lending also has been a bright spot for lenders at a time when mortgage refinancings have declined. Profit margins on home equity lines of credit are twice as high as those on other consumer-banking products such as credit cards, Morgan Stanley analyst Ken Posner estimates, largely because a robust housing market has helped keep credit losses low.

But rising short-term interest rates have put a damper on the home equity market's rapid ascent. The value of home equity lines of credit at commercial banks increased 17 percent in September compared with the same time the previous year, according to the Federal Reserve. That was well below the 45 percent annual growth rate seen last fall. On a month-to-month basis, home equity line balances, which totaled $438.7 billion at the end of September, have been mostly flat since the end of July.

Lines less attractive

The surge in home equity borrowing was driven mainly by the rising popularity of home equity lines of credit, which give homeowners the right to borrow up to a certain amount either all at once or as needed. Home equity loans provide borrowers with a lump sum and a fixed rate.

But rising interest rates have made home equity lines of credit less attractive than they were as recently as the summer of 2004, when the prime rate was only 4 percent. Rates on home equity lines currently average 7.22 percent, according to HSH Associates in Pompton Plains, N.J. That compares with 4.68 percent in June 2004, when the Federal Reserve was just beginning its campaign to raise interest rates. In addition, the rate difference between a home equity line of credit and a fixed-rate loan has narrowed because short-term market rates have risen more quickly than long-term rates. Rates on fixed-rate home equity loans have edged up in the same period only slightly, to 7.36 percent from 7.05 percent.

As rising rates begin to pinch borrowers' pocketbooks, the number of homeowners paying off their credit lines has increased.

"We're seeing significantly higher payoffs versus this time last year," says Alan Dakay, president and chief executive of Citigroup Inc.'s home equity division. At Wells Fargo, the number of borrowers prepaying their credit lines has climbed 50 percent this year.

Freddie Mac, a supplier of financing for mortgage loans, estimates that homeowners will use cash-out refinancings, which involve taking out a new mortgage with a higher loan balance than the existing mortgage, to pay off about $60 billion in home equity loans and lines of credit this year, an increase from about $40 billion last year. Other borrowers are paying off existing credit lines when they sell their homes.

Faced with rising interest rates, some borrowers are opting for more predictability. At Wachovia, 36 percent of borrowers are taking out fixed-rate home equity loans, an increase from only 25 percent last year. Lenders, meanwhile, have introduced new features that allow borrowers to lock in the rate on some or all of their credit line. At Bank of America Corp., the number of new borrowers who elected to fix the rate on at least a portion of their home equity lines has doubled since January.

Fixed-rate home equity loans typically make more sense for borrowers who have a one-time need for cash, such as paying off credit card debt or consolidating existing auto loans.

Money over time

A home equity line, on the other hand, can be a better choice for someone who needs the money over time, for example, to pay college tuition or finance a long-term remodeling project. That is because borrowers pay interest only on the money that they have actually drawn from the line of credit; they also can elect to make interest-only payments during the early years.

Borrowers who took out a line of credit several years ago and have been bitten by rising rates may be able to lower their costs by taking out a new credit line because the average amount above the prime rate that lenders charge has dwindled in recent years. Some lenders, however, charge early termination fees, often $250 to $500, if a line of credit is closed within the first three years.

Locking in a fixed rate on a portion of their credit line can make sense for some borrowers, says Greg McBride, senior financial analyst with Bankrate .com.

"You can mitigate the risk of rising rates in the short term while still preserving your ability to tap into the line of credit as needed," he says.

Terms and costs for locks vary.

At National City Corp., for instance, borrowers who lock in a portion of their credit line can elect to make interest-only payments on the locked-in portion for the first seven years or pay interest and principal on that amount over five, 10, 15 or 20 years.

National City charges $50 each time a borrower wants to fix the rate on some or all of the credit line; SunTrust Banks Inc. levies a $15 fee. At Bank of America, borrowers can take up to three locks at no charge.

Four approaches to rising rates

Here's a look at some popular ways to tap the equity in your home now that interest rates are rising.

•Home equity lines of credit: Can still make sense for borrowers who do not need cash all at once. Although lines of credit are vulnerable to rising interest rates, borrowers only pay interest on the amount of money actually drawn.

•Fixed-rate options on home equity lines: Allow borrowers to lock in the rate on some or all of their line of credit. This can provide a hedge against rising rates, while maintaining borrowers' ability to tap the credit line as needed.

•Home equity loans: Provide borrowers with a lump sum and a fixed rate. Borrowers are protected against rising interest rates but must pay interest on the full loan amount even if they only spend a portion of the money.

•Cash-out refinancings: Allow borrowers to pull out extra cash when refinancing their mortgage. Whether this makes sense depends in part on the rate on the existing mortgage and the cost of refinancing.

What are people saying about mortgages today:

Rates on 30-year mortgages edged down last week to a seven-month low. Mortgage-giant Freddie Mac reported Thursday that 30-year, fixed-rate mortgages fell to 6.3 percent, down slightly from 6.31 percent two weeks ago. It put rates at the lowest level since they were at 6.24 percent the first week of March.

Bank of Hawaii, Central Pacific Bank, Territorial Savings Bank and Wells Fargo Home Mortgages all cut their 30-year mortgage rates to 5.75 percent this week.

Most people think of a mortgage as a means to an end. After all, you buy a house, not a home loan. But a mortgage is much more than the path to homeownership. It is a financial instrument that must be managed, just like any other financial investment.