Fed Announcement Makes HELOCs a Better Deal


NEW YORK (MainStreet) -- Thanks to the Federal Reserve, a home equity line of credit, or HELOC, now looks like an especially appealing way to raise cash for both a short-term need or to hold in reserve as a rainy-day fund.

As the financial markets whipsawed over worries about slow economic growth and debt in the U.S. and Europe, the Fed announced Tuesday that it would keep short-term interest rates near zero through the middle of 2013. An unprecedented two-year guarantee of low rates makes it safer to bet on a variable-rate loan like a HELOC. You know your payments will be predictable for the foreseeable future.

Currently, many lenders offer HELOCs with starting rates from 3% to 3.25%. After a few months the rate begins getting monthly adjustments, figured by adding a margin to the prime rate. Borrowers with good credit can get margins of two percentage points, while prime is 3.25%, producing an attractive HELOC rate of 5.25%. You cannot beat that with a credit card.

Like a credit card, a HELOC is a line of credit, allowing the borrower to take any amount up to the credit limit. Generally, the borrower is only required to pay interest, though costs mount if you never pare down the balance.

It would be possible to borrow against home equity with a cash-out refinancing, getting a fixed rate around 4.4%, according to the BankingMyWay survey. That way you could avoid worry about having to pay higher rates later. But you’d probably have to spend thousands on closing costs, while closing costs on HELOCs are typically very low, often only a few hundred dollars.

For long-term borrowing, a home equity installment loan is probably a better choice than a HELOC, because the interest rate is set for the loan’s life and closing costs are lower than on standard mortgages. But rates are averaging 6.6% on 36-month installment loans, 8% for 180-month loans, so the HELOC would definitely be cheaper if you’ll pay the loan off before rates rise, which probably won’t be for at least a couple of years.

What are the downsides? The biggest, of course, is that you could lose your home if you fail to make loan payments. Rates are low because the home serves as collateral.

Also, lenders are pretty picky these days, and it can be hard to get the lowest rates advertised. You’ll need a top-quality credit rating and you’re sure to be turned down if you’re already struggling with a lot of credit card debt, car loans and other obligations.

Of course, to get a home equity loan you must have home equity, which means your home must be worth more than you owe on your mortgage. That knocks out a lot of homeowners who have been driven underwater by the collapse in home prices.

But if you’ve owned your home for eight or 10 years or longer, there’s a good chance it is worth more than you owe. Before spending money on a loan application, get an estimate of your home’s current value on Zillow.com.

Enhance your chances of approval by paying down credit cards and other debt. Make sure your credit history is accurate. Then use the BankingMyWay search tool to find an attractive deal.

Be sure to look past the rate to find out about closing costs, and to learn how your floating rate will be adjusted.

—For more on the fragile real estate market, visit MainStreet’s “Foreclosure” topic page for our latest coverage!

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