HELOCs: Everything You Need to Know

Are you considering a home equity line of credit (HELOC)? You can avoid costly mistakes by knowing the essential facts before funding.

The television industry loves to financially reward trivia hounds on shows like Who Wants to Be a Millionaire?, Are You Smarter Than a 5th Grader?, and Jeopardy. It's certainly a glamorous way to reach your monetary goals. Unfortunately, memorizing minutia doesn't come easy for everyone. It might be more reasonable to learn what you need to know about just one subject: the home equity line of credit.

HELOC for ongoing expenses only

HELOCs are best used for funding small, ongoing expenses. If you don't need the borrowing flexibility provided by a HELOC, there's no reason to take on its riskier, variable rate debt. For fixed-budget projects like remodeling and debt consolidation, consider the more conservative structure of a fixed-rate home equity loan.

Keep borrowing in check

Most lenders base the HELOC credit limit on 80 percent of your home's value, less the balance of your first mortgage. While it's technically okay to borrow up to your credit limit, you should use extreme caution before doing so. If you max out the HELOC and the value of your home drops-which isn't all that unlikely in the current real estate downturn-you'll end up owing more than the home is worth. If you can't make the payments, the bank can take your house. Selling won't be an option, either, unless you have the cash to cover the shortfall.

Know the variables

Many HELOCs have low introductory interest rates. This will save you money upfront, which is great-but don't be lulled into not budgeting for the regular rate when it hits in the future. Know the date when that teaser rate will reset and what your regular rate will be. Also, be sure to understand how often and by how much your HELOC rate can change.

Avoid inactivity fees

Select a HELOC that doesn't charge an inactivity fee. The added charge is the bank's way of making money even when you don't borrow any of it from them.

Check with your bank first

Start shopping around by contacting your bank first. You might get a better deal just for being a deposit customer. Ask if you can get a break on the interest rate by linking up your checking account to the HELOC and enabling automatic payments. Once you have a reliable quote from your bank, hit the streets and collect a few more from other lenders. This is the only way to know if you're getting the best deal possible.

If the trivia show road to riches isn't for you, maybe you're ready to generate some financial flexibility with a HELOC instead. One last thing: Remember not to provide your loan application answers in the form of a question.