And a HELOC can be a wise choice. Because it is a secured loan backed by the borrower's equity in a home, the interest rate can be attractive indeed. Many start in the low single digits and remain in the single digits even after the rate starts to float some months later. TD Bank says its best deals now start at 2.75%, compared with typical credit card rates of 13% to 15% or more.
But the HELOC borrower does face the risk of a higher rate later. These loans typically charge a "margin," or set number of percentage points, above the prime rate. Since the prime rate has been steady at 3.25% since the start of 2009, this has worked well for borrowers. But that could change any time. The prime rate was over 8% as recently as 2007.
During the initial "draw" period, when money can be borrowed, borrowers are generally required to pay only interest on the loan. But when the "repayment" period begins five or 10 years later, principal payments are required as well, calculated to bring the debt to zero over the loan's 20- or 30-year life.
Because future payment requirements are unpredictable, HELOCs are best used for short-term needs — for expenses that can be paid off fairly quickly.