Questions to Ask About Equity Lines of Credit

Home equity lines of credit provide you with a revolving credit capability. In exchange for certain fees and interest payments, you can can repeatedly draw up to the maximum amount of the credit line, pay it down and draw again. Taking out an equity line of credit with your house as collateral for the debt can facilitate new business ventures or allow you to pay off high interest credit card debt with low interest debt. To do this, you need to open an equity line of credit with terms that meet your specific needs.

Rates and Fees?

Ask your lender to explain details of interest rate and fees. Some lenders charge closing costs. Others offer a "no fee" closing. Some lenders renew the line of credit periodically and charge another fee at that time. As a Federal Reserve Board article on the subject of equity lines of credit points out, the APR, or annual percentage rate that your lender quotes you for a home equity line of credit does not account for fees. Get a more realistic understanding of your actual interest rate including fees and closing costs with a real estate calculator. Access a number of useful rate calculators at the Mortgage-Calc website. If you plan to draw most of the money from the credit line for the greater part of the loan period, you will do better with a line of credit with a low interest rate and higher fees; if you plan to draw less often and for smaller amounts, you will do better with a credit line with lower fees and a higher interest rate. Some lenders will require you to draw a certain percentage of the line of credit when you open it and not to repay it for some period of time.

Fixed or Variable?

Does the line of credit have a fixed interest rate or a variable rate? As of September, 2010, the U.S. prime interest rate (Prime Rate), a basic indicator of secondary rates, such as home equity loan interest rates, has dropped to a more than fifty-year low of 3.25 percent. During that period, however, the Prime Rate climbed above 12 percent four separate times, and in 1981 peaked at nearly 21 percent. A variable home equity line of credit rate may pose considerable rate-increase dangers. At 3.25 percent, the current rate, you will pay about $135 in interest each month. At 12 percent, you would pay $500 each month.

What Factors Affect Your Line of Credit?

Some lenders require you to repay the line of credit once each year and not to withdraw again for 30 days. This poses no problem if you use the line of credit to fund occasional short-term investments, but if you will use it to fund a long-term investment or an investment with an uncertain payoff date, you could run the risk of a default. Ask your lender what could cause a reduction in your credit line or a freeze (basically a cancellation of the line of credit). Some lenders include clauses that allow them to freeze or reduce your line of credit if your financial statements weaken or the house loses value.