Home equity loan rates hit lowest levels in years

Home-improvement buffs, parents of college-bound children, debt consolidators, take note: If you are thinking of tapping into your home equity, the rates look better than they have in years, according to a new Bankrate.com survey.

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You can pick your flavor -- both the variable-rate home equity line of credit and the fixed-rate home equity loan look good, thanks to six interest rate cuts issued this year by the Federal Reserve Board. The Fed has brought the prime rate down from 9.5 percent to 6.75 percent since the beginning of the year, bringing home equity rates tumbling down with them.

In this week's Bankrate.com National Index survey -- a snapshot of the rates of the 50 largest banks and 50 largest thrifts in the 10 largest metropolitan areas in the United States -- the average home equity line of credit (HELOC) rate slumped to 6.98 percent That's the lowest rate in eight years.

This figure, however, includes those low introductory rates some lenders offer on HELOCs, which let borrowers take out a revolving line of credit backed by their homes. Without those introductory rates, the average would be about a half-percentage-point higher -- in the 7.5 percent neighborhood.

Home equity loans, in which a borrower takes out a set amount of money to be repaid over a defined period, are higher. They clocked in at 9.02 percent in this week's national survey. The average home equity loan rate has been lower just once since Bankrate began tracking the rate in 1997: It hit the 8.9 percent range for a five-week stretch in mid-1999.

It's sit-back-and-enjoy time for borrowers who already have taken out variable-rate home equity lines of credit -- their interest rates have fallen with every Fed action.

But what is a new borrower to do? Both types of equity loan offer low interest rates. In most cases, the interest rate is tax deductible, adding to the savings. Strictly by the numbers, the HELOC obviously looks better. Numbers alone, however, don't tell the whole story.

Should you put your equity to work?
First, there's the question of whether you should tap into your home equity at all. Most financial experts say it can be a good way to pay for home improvements, a college education, or to consolidate high-interest credit card loans. The same experts, however, add a big caution: Home equity loans and HELOCs only make sense financially for borrowers with the discipline not to run up additional debt. Too many consumers fall into the habit of using credit cards again, boomeranging them back into debt -- but this time, without the cushion of home equity to fall back on.

Also on the downside, the home itself is security for the loan, albeit a second lien position in most cases. Defaulting on such a loan puts your home at risk.

Security vs. short-term savings
Lines of credit have lower rates, which look even better to borrowers at first, when attractive introductory rates are in effect. These rates commonly extend for three months to a year, at which point they revert to a higher rate. The rate the borrower will pay at conclusion of the introductory period is the true measure to consider.

Due to the revolving nature of lines of credit, borrowers that are adding to the balance in stages -- renovations, for example -- frequently use HELOCs By no accident however, the rate is higher at the point when the balance is most likely highest.

With fixed rates poised to move below 9 percent on average, borrowers preparing to tap into home equity may want to weigh the benefit of a fixed rate and monthly payment that prevails regardless of future interest rate swings. After all, the 1.5 percent advantage of a variable-rate HELOC could evaporate, and then some, should the Fed reverse course on interest rates next year.

Check your time horizon
In the final analysis, the loan that's right for you may depend on how long it will be before you pay it back.

Those with shorter-term paybacks in mind -- perhaps due to a forthcoming bonus or sale of the home -- should consider HELOCs They can still reap the rewards of lower variable rates, particularly those with introductory offers.

Borrowers with existing loans outstanding would likewise want to consider their prospective payback period -- as variable-rate loan holders would likely trade into a higher rate now with the potential to recoup costs and realize interest savings only over a longer period that brings significantly higher rates.

Those looking to refinance their current fixed-rate loan at a lower rate may well see interest savings as a result, provided the remaining term isn't unnecessarily extended.

The best advice? Don't "payment shop," but look at the total payback over the life of the loan.

Use Bankrate.com's search engine to find the best loan terms for you.

Greg McBride is a financial analyst for Bankrate.com. For advice regarding your specific situation, please e-mail one of Bankrate.com's Q&A experts or visit the Advice & Community channel on Bankrate.com.