Now that HELOC rates are so low, many borrowers are looking for smart ways to use their lines. In a recent Scripps News column, a reader asked if he should use a HELOC to pay off his car loan.

Columnist Steve Bucci pointed out both the pros and cons and said that the reader should weigh both sides. While it’s true that there are some benefits to using a HELOC as a car loan replacement, I’d like to point out that the drawbacks can be enormous.  Bucci writes:

” First, the loan is usually a variable interest rate loan that may change — as in go up — monthly. Second, if you don’t aggressively pay down the amount you borrow from the HELOC, that loan could outlive your car. This could result in you paying on the HELOC while having a new loan for your next vehicle. Additionally, adding the car loan amount to your line of credit balance decreases the amount of equity available in your home and could be a problem should you need to sell your home unexpectedly.”

Unlike a traditional car loan, your HELOC is secured by your home. HELOC debt is also much harder to discharge. Why put your property at risk in order to finance a car?

photo credit: dave_7

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Is a HELOC Right for You?

It’s been months since banks first began closing HELOC lines due to the worsening real estate market. But, customers continue to receive HELOC freeze and closure notices in the mail.

Monitor Bank Rates gives this concerning antedote:

“A close friend of mine had his HELOC closed by JP Morgage Chase on a home he and his wife owned. They didn’t owe any money on the HELOC but the interesting part of this story is they didn’t owe any money on their home at all. No primary or secondary mortgage balance, they owned their home outright but Chase still closed their home equity line of credit.”

Wow…a HELOC cancellation while the homeowner owes nothing? That’s definitely worth taking note of.

photo credit: Thairms

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HELOC Freeze Help

Now that HELOC rates are so low, many homeowners are tempted to pay off their original home loans with home equity. While this strategy may seem like a smart move at first glance, there are some serious risks.

Banking My Way explains:

“…There is a serious problem — because HELOC rates are variable, you can’t be sure the savings will last. The loan that charges 4 percent today might charge 6, 7 or 8 percent sometime later.

Many HELOCS figure monthly adjustments by adding a fixed “margin” to the prime rate. With today’s prime at around 3.25 percent, a HELOC with a 3.5 percent margin would charge 6.75 percent. You’d probably do better refinancing with a fixed-rate mortgage at around 5 percent.”

When your HELOC rate adjusts (as it almost inevitably will), you may be faced with payments even greater than your current bills. Best bet: refinance if you need a lower rate. The HELOC simply wasn’t designed for this kind of maneuver.

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Is a HELOC Right for You?

If you’ve been waiting to take advantage of low HELOC rates, now may be the time. PenFed is offering HELOCs at just 3.25%.

Monitor Bank Rates explains:

“Pentagon Federal Credit Union is offering a home equity line of credit (HELOC) with an annual percentage yield (APR) of 3.25 percent. The rate is prime plus 0 percent as of March 26, 2009. This rate is for a variable line of credit and the rate changes once per quarter.”

HELOC rates are now lower than the interest most people are paying for their student loans. Although home equity rates are variable, they’ve only gone down in recent months.

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How to Get the Best HELOC Rates and Terms

Many HELOC borrowers are surprised when they’re turned down for mortgage refinancing programs. Why are banks sending them away? Because a growing number of HELOC / second mortgage lenders are refusing to subordinate their loans (agree to be paid after the primary lender in case of foreclosure).

The Chicago Tribune reports:

“Find out if your second lender will subordinate to your first lender. If you have a first and a second mortgage (also known as a home equity loan), find out whether the second lender will subordinate to the new first lender. That will allow you to refinance your first mortgage, while leaving your second loan in place. Many second lenders will not agree to this, and if yours doesn’t, you may not be able to refinance at all unless you pay off the second loan.”

In past years, HELOC lenders almost always agreed to subordination. But, now that foreclosure rates are so high, many are trying to force potential refinancers to pay back their second mortgages early.

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HELOC Questions and Answers

Some financial experts advise clients to take out a HELOC as a security against potential job loss. But, this strategy only works if the homeowner is currently employed when the equity loan closes.

WalletPop reports:

“That’s a possible step to take before you lose your job, but not after you’ve lost it. Why? You most likely won’t qualify if you don’t have a job, especially during these times when skittish lenders often aren’t lending to people who are still employed. And even if you do qualify, expect to be charged a whopping interest rate. Many financial experts say a HELOC is the last of the last resorts.”

Unfortunately, it’s often difficult to predict layoffs. However, many applicants are able to take out a home equity line of credit with few closing costs and let the line sit unused until trouble arises.

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Is a HELOC Right for Me?