With the Fed continuing to raise a key short-term rate that, in turn, pushes rates higher on home-equity credit lines, some borrowers are finding they can save money by refinancing their credit line and their first mortgage into a new 30-year fixed-rate loan.

Interest rates on long-term mortgage loans are hovering around 6%, while the average rate on a home-equity line of credit is 6.85% and likely to hit about 7.04% next month as the Fed’s action Tuesday sinks in, according to HSH Associates, a mortgage-rate research and publishing company.

The rate on a 30-year fixed loan averaged 6.13% this week, the same average seen the same week last year, even as the Fed raised short term rates 2.5 percentage points over the year, said Keith Gumbinger, vice president of HSH Associates.

"Borrowers have found the cost of their home-equity line of credit has risen above what they can get in the long-term, fixed-rate mortgage market," Gumbinger said.

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"This is an excellent opportunity to step away from the continual increases in short-term interest rates," he said.

About one-fourth of Americana Mortgage’s home-equity credit-line borrowers opted to roll their debt into a new, fixed-rate mortgage recently, said Bob Moulton, founder of Americana Mortgage Group in Manhasset, N.Y.

"They refinanced ... into one first mortgage to eliminate the risk that’s associated with the home-equity line of credit right now," Moulton said.

Some lenders charge the prime rate on home-equity lines of credit, while many charge prime plus an additional margin on top. Before the Fed action Tuesday, the prime rate was 6.25%, and banks are likely to raise it to 6.5% soon.

It’s not the first time borrowers have watched short-term rates rise as long-term rates stayed stable — also called a flattening yield curve — but it’s the first time it’s happened with this much debt subject to rising rates.

Homeowners owed more than $911 billion on home-equity lines of credit and home-equity loans (which generally have fixed rates) in the first quarter of 2005, compared with $492 billion at the end of 2000, according to the Federal Reserve.

The year 2000 was the last time the yield curve flattened, Gumbinger said. "There’s considerably more home-equity debt in play today than there was last time the yield curve was so flat," Gumbinger said.

Dropping the ‘piggyback’

Some home buyers might have used a home-equity credit line as a second "piggyback" loan to avoid private mortgage insurance (something most lenders require if your first mortgage exceeds 80% of the home’s value).

Now, if their home’s value has risen enough, they might be able to refinance their credit line plus their first mortgage into a new first mortgage that’s less than 80% of the home’s value, thus locking in a fixed rate on their entire mortgage debt and eliminating the need for mortgage insurance.

"If you utilized a home-equity line as the second mortgage component of your piggyback, which is certainly possible, now might be an opportunity [to] get rid of that piggyback structure," Gumbinger said.

Not so fast

Of course, there are plenty of caveats to consider before rushing out to refinance your credit line.

The cost of refinancing may exceed any benefit. For instance, if you’re going to be in the house for less than five years, you may not recoup those costs before leaving the house, Moulton said.

Consider prepayment penalties. Prepayment penalties may take too big a bite out of any potential savings. "You need to be aware of those on both your first mortgage, if it happens to be an ARM, and on a home-equity line of credit," Gumbinger said.

That great 30-year-fixed rate. Homeowners who locked in a low fixed-rate mortgage in recent years are unlikely to get a lower rate now. Don’t try to save money on a small portion of your total mortgage debt only to pay a higher rate on a larger pool of money. For instance, if your rate on a 30-year-fixed is 5.5%, "you’re not going to want to touch that," said Bob Walters, chief economist with Quicken Loans, in Livonia, Mich. "That’s a great rate." But if your first lien is a 30-year loan at 6.25%, then rolling that loan and your credit line debt into a new first mortgage could make sense, he said.

Don’t incur mortgage insurance. Before you roll those two loans into one, consider the possibility that doing so will give you one loan that tops out at more than 80% of your home’s value — leaving you on the hook for mortgage insurance. "Even at home-equity-line-of-credit rates, it’s still far more advantageous from an economic perspective than mortgage insurance is," Walters said, noting that mortgage insurance can range anywhere from .5% to 3.5% of the loan amount per year, and it’s not tax deductible.

How much variable-rate debt do you have outstanding? Given the costs of refinancing, if the money borrowed on your home-equity credit line is a small amount, don’t bother. "If it’s a small amount of money, the numbers may not work as well. The larger the line of credit the more interest rate exposure a client has," Moulton said, noting that someone with $50,000 outstanding on a home-equity line of credit may find the interest-rate savings don’t justify the refinancing costs, while someone with $300,000 borrowed against a line of credit likely will.

Short-term rates may drop next year. Who knows what the Fed will do next year? "Probably more than half of all the rate increases you’re likely to endure have already occurred. That may be it for the pain of rising rates," Gumbinger said. "You don’t necessarily want to throw everything out for a process that may be coming to a conclusion." Others agreed. "If rates peak next year and then drop back, you don’t get the advantage of them dropping back if you fix it in right now," Walters said.

Don’t rush in. "While there are some circumstances where we counsel folks to indeed fix in that HELOC, in many of these cases we tell them to leave it in place because the funding costs they have now are more advantageous than they could get if they locked it down," Walters said. "Every situation is different. A lot of cases, standing pat is the right answer."