Best way to shop for a HELOC

Dear Dr. Don, Is a HELOC (home equity line of credit) only available from the bank that I have my first mortgage with, since they hold the title deeds to my property? -- Line Limits

Dear Line, Your current first mortgage lender may be willing to offer you a deal on a home equity loan because of its knowledge of your property and payment history. It's a good place to make your first inquiry, but you aren't limited to dealing with the lender that holds the first mortgage.

You want to consider the loan's closing costs, and the particulars associated with the interest rate on the line of credit. A HELOC is a variable, adjustable-rate loan. You want to know the intricacies of how the interest rate can change over time. Typically the line is priced at a spread to the prime rate, but the rate can have a floor, ceiling, maximum one-time adjustment and maximum lifetime adjustment.

For example, Bankrate's national average for a HELOC is, at this writing, 5.56 percent.

While 5.56 percent doesn't seem like a bad rate, historically HELOCs were priced right on top of the prime rate. Paying prime plus 2.26 percent is a horrible deal if interest rates start to go higher. The 2.26 percent is known as the "pricing spread" to the index. When the prime rate changes, the HELOC's rate will also change at the next reset date. The rate changes to the new prime rate, plus the pricing spread subject to any constraints on the rate adjustment.

You can track the prime rate using Bankrate's "Prime rate, fed funds, COFI" Web page. Also take a look at the Bankrate 2011 Interest Rate Forecast, especially the feature, "HELOCS, home equity loans may get costlier."

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