Home Equity Lines of Credit (HELOC) are sometimes referred to as ‘second mortgages,’ but this isn’t necessarily true. These loans act much the same as a credit card. HELOCs are lines of credit with a dollar limit (determined by your homes worth and how much of it you own) which you can draw from whenever you want, and for any amount you want (there are some limitations, but let’s keep it general for now). Usually these loans are used for home improvements or other costly maintenance, but there really are no rules on how to use the money, as long as you make your monthly payments. Let’s take a look at some reasons for taking out and using a HELOC.

Don’t Move, Improve!
Several homeowners are turning to large renovations on their existing homes rather than moving to a new one. With the market in the state it’s in, selling your home is no longer a smart option. If you purchased your home in recent years, it’s very likely that if you sold it today you would be losing money. Therefore people are using the equity in their homes to renovate and make them better. Between additions, upgrades, and remodels, people are essentially building a new home from their old one, instead of dealing with the hassle of buying and selling. There’s another reason people are putting down the ‘for sale’ sign and picking up a hammer; renovations build value. The more updated and expanded your home is, the more its value increases. So a few years down the road when you do sell, you’ll make more in profit than you spent on renovation.

Money For The Lean Months
If you’re a seasonal worker or are self employed, a HELOC may be the way to make sure you don’t starve during your off months. Perhaps you have a landscaping business that is very productive and employs many people. But every year when the snowy season comes, plowing roads just doesn’t pay the bills. Not to mention you don’t want to lose all your employees because you can’t pay them as much as they earned during the summer. If you use money from a home equity loan to bolster your accounts during those times, and pay it back during your busy months, you can even out your expenses and maintain a steady flow of cash all year.

Make Credit Cards Go Away
High interest credit cards can be the thorn in your side that just won’t go away. With a HELOC, you can pay off your credit card and essentially ‘transfer’ the balance to your new loan. The interest on home equity loans is significantly less than many credit cards. Average rates for high interest cards can be anywhere from 20% to 30%, while HELOCs are currently between 4% and 6%. A scenario (warning, math ahead!):

Say you have a $15,000 balance on a 20% credit card, and planned on paying it off in 5 years. If you paid off that card with a 5% home equity loan, and paid it down within the same 5 years, you’d save $6,860.40 in interest! Not to mention going from a monthly payment of $397.41 to a much more manageable $283.07. Sounds good to me!

A new and disturbing trend is starting to ripple through the banking world, one that changed the airline and retail industries over thirty years ago. In the face of huge drops in profit from the now infamous sub-prime mortgage debacle, banks are looking to find any way possible to recoup those losses, and they want to do it fast. Their answer: price optimization.

In other words, charging different prices for the same product. While this isn’t a new idea in general, its application to the banking world is less than a year old. Airlines charge different rates to the same destination based on the time of year (ever try getting a flight around the holidays?) and retail shifts their prices based on how new or how popular a product is. Now banks are looking to charge different rates of interest on their loans, based upon the customer.

But it’s not going to work like you think. In the past, the more relationships you had with a bank (checking accounts, savings accounts, etc) the more perks you got. Perhaps it was a better interest rate on a CD or no fees on an account. With price optimization, the more relationships you have (and indeed, the more money you have in general) the higher your interest rate will be. Why? Because banks want money, and the need it fast. Here’s a scenario:

A 31 year old professional walks into his local bank branch and expects to get a very good rate on a loan. After all, he has an extremely good credit score (785), and is willing to make a 20% down payment on a new four bedroom home. He walks out with an offer of 6.5%, not even close to the industry norm of 5.8%. If he goes with them, he could end up paying over $21,000 more over the life of the loan.

Essentially the banks are looking to eek out as much interest revenue as possible in the shortest amount of time possible. Therefore the more money you have the higher interest rate you’re able to pay. There are many other factors that play into it as well (up to 20,000 in some models). Computer software takes your information and after running it through filters and projection models, determines how much you would be willing to pay. Live in the Midwest? You’re more likely to eat a higher rate than someone in New York. Applying at a local branch? You’re more likely to take a higher rate than a phone or internet application. Are you a lifetime customer who doesn’t have accounts anywhere else? You’re going to get hit just as bad as an uneducated consumer with a low credit score.

The lesson here is to be aware. There is nothing that says you have to take these higher rate offers. Shop around, do some research, make some calls. Essentially the banks are hoping that you don’t do these things, and take their word for granted. The best thing you can do is arm yourself with knowledge and challenge your bank to give you a better rate. If they don’t, then move on to one that does. Industry consultants say that eventually this approach will phase itself out, that once people start looking around for better rates the computer software will start spitting out lower rates to compete. However for the short term, banks are looking to squeeze every dime out of you they can. Don’t let them! Take matters into your own hands and become an educated consumer. Now, if we could only do something about airline rates…