All You Really Need To Know About HELOCs

Written by Steve R. Lowry    Thursday, 22 January 2009

A home-equity line of credit (HELOC) works almost like a credit card, only it's secured by your home's equity (the market value minus the mortgage). Whatever the size of your credit line, you pay interest only on the amount you use. If your line's maximum is $50,000, you can borrow $5,000 or $20,000, repay and borrow again as long as you don't exceed the limit. Pointers: 1. Use for ongoing expenses, not big one-time costs. A HELOC comes in handy for paying college tuition or for a multiyear home renovation because you can dip in only as needed. You might also have one in place for emergencies if, say, you lose your job. If you're borrowing for one big expense, you're better off with a fixed-rate home-equity loan. 2. Hunt for a low permanent rate. Teaser rates (now less common) go as low as 5.25% but will jump later. All HELOCs charge a variable rate based on prime (currently 8.25%), plus or minus a margin. Look for incentives: A bank may shave off 0.25% if you do your checking there and an equal amount if you sign up for automatic payments. 3. Never borrow more than 80% of your equity. Borrow more and you'll wind up with a higher interest rate. Plus you'll leave yourself vulnerable to having your equity wiped out by a modest decline in home prices. 4. Shop your own bank first. Your mortgage lender may cut you a deal since you're already a customer. "They have a lot of your records on file, which can accelerate the process" and cut administrative costs, says Greg McBride, senior financial analyst for Bankrate.com. Next, get quotes from at least two other lenders, starting with a credit union or local bank. Also check rates at bankrate.com. 5. Avoid these gotchas. Pass on HELOCs that charge a $50 to $100 annual inactivity fee or require a minimum draw at closing (meaning you have to borrow and start paying interest on, say, $10,000 immediately). Also, beware of early-termination fees-either a few hundred dollars or a percentage of the balance-for closing the credit line within the first three years. End your HELOC early and you could be hit with those fees retroactively. 6. Run from a balloon. HELOCs have a set term, typically 10 years, during which you repay both interest and principal. But watch out for so-called balloon HELOCs with interest-only payments. Your monthly bill will be lower, but you'll owe all of the principal once the HELOC comes due. In the worst case, if you can't repay or refinance, you might have to sell your home. More often, you'll wind up owing more after paying thousands of dollars.

Last Updated ( Thursday, 22 January 2009 )