HELOCs remain cheap, flexible loans

Gray house on pile of money

A home equity line of credit is a cheap way to borrow money right now -- if you can get one.

The average line of credit costs only 5.56%, according to our latest weekly survey of major lenders taken April 6. This is a far lower rate than you'll find with most other consumer loans.

In many parts of the country, lenders offer HELOCs for less than 5% to homeowners with good credit.

There's no reason to think these variable-rate loans will get any cheaper this year.

The cost of most HELOCs is determined by adding a full point or more to the prime rate -- the floating interest rate banks charge their best commercial customers. That's why you'll see rates expressed as "prime plus 1.50%" or "prime plus 0.75%."

Prime is only 3.25% right now, the lowest it's been since 1955, because the Federal Reserve has driven short-term interest rates extraordinarily low to help the economy rebound from recession.

At some point late this year or early next year, the economic recovery should be far enough along for the Fed to reverse course and allow interest rates to begin creeping up.

When that happens, the prime rate will increase, and lines of credit will become more expensive.

But HELOCs should remain a good option for everything from home improvements and college bills to paying down high-cost credit card debt.

Think of the savings you'll pocket by paying off credit cards charging 19% or more with a loan costing 5% or less.

A line of credit allows you to use as much or as little of the loan as you need, and you can pay it back on your own terms.

You only pay interest on the amount that you use, and you can borrow money and pay it back over and over again. If you don't use it, it costs you nothing.

Because your house secures the loan, any interest you pay will likely be tax-deductible.

Unfortunately, some homeowners won't qualify for a HELOC because they lack the required equity in their homes.

That's a big reason banks made less than $60 billion of new home equity loans and lines of credit in 2009, down from $430 billion in 2006. We haven't seen the numbers for 2010 yet, but no one was expecting a big rebound.

To figure out what size HELOC you can get, subtract the balance you owe on your mortgage from what your home is currently worth. Your equity is the difference between what your home is worth and how much you owe.

Most lenders require borrowers to retain 20% equity in their home after taking the HELOC into account.

If, for example, your home is worth $200,000, and you owe $110,000 on your first mortgage, then you have $90,000 in equity to borrow against with a second mortgage.

Since you'd need to retain 20%, or $40,000 in equity, you could qualify for a $50,000 line of credit.

Our line of credit calculator can help you do the math and determine how much you can borrow.

The average cost of a traditional home equity loan continues to be high – 6.98% in our most recent survey.

That's because so many borrowers have defaulted on home equity loans, particularly those used as piggyback loans to buy a house with little or no money down.

Some lenders have stopped making traditional home equity loans altogether. Those that remain in the market are charging higher rates, particularly in high-foreclosure states such as California, Florida, Arizona and Nevada.

Home equity loans also are less flexible than lines of credit. You get all of the money up front and adhere to a repayment plan that requires you to make the same payment each month until the debt is retired, much like a mortgage. In fact, home equity loans often are called second mortgages.

With HELOCs so much cheaper, there's no compelling reason to go with a traditional home equity loan right now.

If the time comes when the interest rate on your line of credit is higher than what you would pay for a home equity loan, you could refinance into a fixed-rate second mortgage.

But we don't think that will happen anytime soon.

Take advantage of the lower HELOC rates while you can -- and if you can.

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