 Dear Dr. Don,
Is it better to take our chances with a variable rate equity line of credit that, even though the rate is going up, as we pay the amount down our payments will go down and in the long run pay less interest than if we lock in the rate and have the credit amortized over 15 years?
-- Denise & Ken Credit
 Dear Denise and Ken,
A home equity line of credit, or HELOC, is, as you point out, a variable-rate loan, whose rate is typically priced at a certain margin higher than the prime rate. Since the prime rate moves in lock step to changes in the targeted federal funds rate, and the Fed is widely expected to raise rates at least one or two more times in this interest-rate cycle, you'd have to expect future rate hikes with the HELOC.
A home equity loan is both a fixed-rate loan and a self-amortizing loan. That means that the monthly payment is large enough to both cover the interest expense and pay down the principal balance over the life of the loan. Both are second mortgages. The question of whether the line or the loan is right for you depends on what you plan to do with the money, how much flexibility you have in your monthly spending and the terms of the two loans. HELOCs can be structured in many different ways. It's typical that in the early years of the loan the monthly payment is only interest and any paying down of the loan balance can be drawn down again until some point in the life of the loan when the HELOC becomes an amortized loan. A
March 3, 2006, Bankrate national survey of these loans has the two rates very close with the HELOC at 7.67 percent and the home equity loan at 7.53 percent. For you to pay less interest with the HELOC in the current interest-rate environment, you'd have to make larger monthly payments than you would make on the home equity loan. In the current interest-rate environment, the argument that the HELOC pays off the loan more rapidly doesn't work, assuming you have the same ability to make additional principal payments on the loan as you do on the line. The following example illustrates the issue:
 | | Example | | | | | HELOC | Home equity loan | | Loan amount: | | Loan term (months): | | Interest rate: | | Monthly payment interest only for HELOC: | | Additional principal payment HELOC: | | Total monthly payment: | | First month's principal repayment: |
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Bankrate has an
interactive work sheet that can help you decide whether the HELOC or the home equity loan is better suited for you. If you expect to use the money at different times during a draw period, or plan on holding part of the line in abeyance for financial emergencies to have some flexibility in your monthly budget to take on the risk of rising interest rates, the HELOC is the better choice. If you're making a single big-ticket purchase and want to lock in an interest rate and a loan payment, then the loan is the better choice.
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