Use a Home Equity Loan Wisely

A Home Equity Line of Credit, or HELOC (pronounced hee-lock) as it is called in my industry, has become as common as SUVs and Starbucks. If you don't have one, I bet you know someone who does. People use HELOCs as an easy way to get lots of cash.

A HELOC, technically, is an Open Ended Deed of Trust, which is a credit line secured against real property, typically a home. HELOCs have a credit limit based on the value of the property used as collateral.

Like other credit lines, a HELOC allows borrowing money up to a pre-set limit. The borrower is billed for the amount borrowed, and can pay back or draw out more at any time. Think of it as a credit card secured by the property.

Once you have the line of credit, the money is easy to get. HEOLOC lenders usually issue checkbooks, ATM cards and credit cards to pull out funds. If you have a $100,000 HELOC with a zero balance, you could write yourself a check for $100,000, go the bank and cash it, walk around all day with $100,000 in a suitcase (consider handcuffing it to your wrist), then deposit it back in the bank the next day and pay down the HELOC balance to zero. When you get your statement at the end of the month, it would show you used $100,000 for one day and you would owe one day's interest for the privilege of using that money.

You can see a HELOC is a flexible tool and can be helpful if used properly. In comparison, a traditional second trust deed, or "closed end loan" behaves just like your first trust deed -- the lender hands you the money at the beginning of the loan and you pay it back at a specified rate over time. You can't draw out the money once you've paid it back. Traditional second trust deeds have advantages over HELOCs in some circumstances, but they are completely different tools for different situations.

Just about every financial institution offers Home Equity Lines of Credit. They all work about the same, but a few are better. Banks vary the terms of HELOCs to attract customers. The variables to compare are the application costs, overall interest rate, annual fee, terms of repayment, early closure fee, and options to lock in the rate later. To be more attractive, a bank might offer a teaser rate, or no costs or fees. It's important to look at everything before signing up.

For example, I had a HELOC on my house through a major national bank, and they called and said if I raised my limit, I'd get Prime Rate minus 1 percent for the life of the loan. Well, that's a pretty good interest rate -- in fact, I've never seen anything better, so I took the bait and signed the documents. The annual fee is $90 per year, which, I now realize, is about $50 higher than I could have gotten at another bank and $90 higher than the annual fee at some credit unions. I keep a zero balance on my HELOC most of the time, so I am not realizing the benefit of the lower interest rate. Every year, I pay the $90 fee for the right to spend $200,000 at the blink of an eye. Of course, if I do run up a balance, I'll benefit from the lower interest, so the $90 fee will make more sense.