Shopping for a Home Equity Line

Is a home equity line what you need?

Before you apply for a home equity line of credit (HELOC), make sure it's the type of loan you want. If you need relatively small amounts of money over time, such as for school tuition, a HELOC may be right for you. If you need a lump sum for a particular purpose, such as building a room addition, a home equity loan would probably be better.

Carefully compare plans

Carefully compare several plans. Examine terms and conditions, annual percentage rates (APR), annual and initial transaction (set up) costs, indices, margins and caps. Some lenders may not charge setup or annual fees, but may charge a higher interest rate in return.

There may be an introductory, or "teaser" rate offered. This is a temporary rate which will have little beneficial value over the life of your loan. Since most HELOCs are variable rate loans, the rate you pay is the sum of the index plus the margin. Indices are expressed as rates and include Prime and T-Bill rates. The margin is explicitly stated in your loan documents and is also expressed as a percentage. For example, if your loan were tied to the Prime rate with a 2% margin, and the Prime rate were 8%, you'd pay 10%. Historical information regarding the behavior of various indices is available on-line and at your local library. A little research will help you determine which index you'd be most comfortable with.

Your variable rate plan will identify a maximum interest rate (ceiling or cap). Your loan may not exceed the rate cap during the life of the loan under any conditions.

Consider a loan which allows amortization--repayment in installments of principal and interest sufficient to retire the debt by the end of the plan. Try to amortize your loan, otherwise, you may incur a balloon payment at the end of the plan.

Negative Amortization

Under certain circumstances, depending on your program, the monthly payments may not adjust adequately to fully account for interest rate increases. In this event, negative amortization may occur. Negative amortization is when in which your loan balance increases. If this condition is a possibility with your loan, discuss with your lender how you can avoid it.

Some lenders may permit you to convert a variable rate to a fixed rate during the life of the plan, or to convert all or a portion of your line to a fixed-term installment loan.

Agreements generally will permit the lender to freeze or reduce your credit line under certain circumstances. For example, some variable-rate plans may not allow you to get additional funds during any period the interest rate reaches the cap.

Borrow Wisely

Perhaps you discover you can borrow much more than you expected, or need. A HELOC may seem to turn your home into a new type of credit card. If you default on a credit card, you may only damage your credit. If you default on a HELOC, you could lose your home.