The Federal Reserve’s recent commitment to keeping short-term interest rates at “exceptionally low levels... for an extended period” makes the home equity line of credit an attractive tool for paying off old loans or borrowing in a pinch.
Many HELOCs carry an initial charge less than 3.5% and ongoing rates only a couple of percentage points higher. Borrowing that cheaply is a great way to pay off credit card debt at 15% or 18%.
HELOCs are variable-rate loans that can change interest rates as often as once a month. That can make them pretty risky for long-term debt, as payments would soar if interest rates go up.
But that danger appears to have diminished with the Fed’s low-rate policy, intended to spur borrowing to help revive the economy.
HELOCs are loans against the homeowner’s equity, or the difference between the property’s current value and the balance remaining on the mortgage. Because the lender can foreclose on the home if you default, the HELOC poses less risk for the lender than an unsecured credit card.
And because HELOCs are floating-rate loans, the lender knows it will always receive a rate consistent with market conditions. The lender’s risk is therefore relatively low, so it can afford to charge less on a HELOC than on a fixed-rate, or “installment” home equity loan. Most installment loans currently charge more than 8%, according to the BankingMyWay.com survey.
After an initial period, typically several months, most HELOCs figure ongoing rates by adding a “margin” to a base rate, such as the prime rate. Borrowers with good credit can get margins of around 2 points. With prime at 3.25%, a typical charge might be 5.25% to 5.5%.
In addition, most homeowners can get a federal income tax deduction for interest paid on home equity loans. That could reduce the HELOC rate to below 4%.
Finally, required HELOC payments are driven even lower because they cover interest only, allowing the borrower to decide when to pay off principal.
Use the search tool to shop for home equity lines of credit. Nationwide banks offer some good deals, like the 3.75% rate from AIGBank (Stock Quote: AIG), or the 3.99% from PNC Banks (Stock Quote: PNC). But be sure to look at your credit union as well, since many offer rock-bottom rates.
—For the best rates on loans, bank accounts and credit cards, enter your ZIP code at BankingMyWay.com.