For Every Loan, a Proper Use

Interest rates on home-equity loans are generally linked directly to the prime rate and change with that rate. This week, the average rate on HELOCs was 7.31 percent, according to Bankrate.com. But the Federal Reserve's sharp rate cut this week, three-quarters of a percentage point, will translate into lower rates on these loans.

As with credit cards, HELOCs allow homeowners to take out as much money as they want, when they want, up to the limit of their line of credit. Also as with credit cards, homeowners don't pay anything on HELOCs until they generate debt, unless -- and this is a big "unless" -- their HELOC comes with a non-usage penalty. Then homeowners may face penalties for not borrowing quickly enough.

Unlike credit card interest, interest on either a HELOC or a home-equity loan may be tax-deductible. (There are limits to deductibility based on size of the debt, what the money is used for and the home's market value.)

Once homeowners borrow on their line of credit, they don't have to pay off the debt in full immediately. As if they were borrowing with credit cards, homeowners can instead make a minimum monthly payment that varies depending on the lender and the amount of money borrowed.

If homeowners end the month with a balance of $4,000, for example, they may have to pay a minimum of $120, depending on the payment schedule set by their bank or lender.

Because payment schedules and terms can vary widely, it's up to homeowners to do their research before taking out a HELOC. Because of this variety and because the credit liens don't come with set monthly payments and terms, some caution homeowners against using a HELOC if they're not absolutely certain they can use the product wisely. Just like credit cards, they can be problematic for some.

Homeowners who have already run up their credit card bills are more likely to run up large monthly payments on their HELOCs. But there is a difference: If consumers miss their credit card payments, they face late charges, hits to their credit scores and the possibility of falling into bankruptcy. If they consistently miss payments on their HELOCs, they risk losing their homes.

And that, financial pros say, is the real danger of using a home-equity line of credit.

Rob Blake, a mortgage loan officer in Colorado, president of Integrity First Mortgage and founder of the Mortgage Insider Web site ( http://www.themortgageinsider.net), said that most consumers aren't savvy enough about debt to be entrusted with a home-equity line of credit.

Blake said he especially hates to see consumers rely on either home-equity loans or HELOCs to pay off credit card debt.

"The studies have all shown and proven that within two years of paying off their credit card debt, the average American is back in debt equally or more," Blake said. "It's ridiculous. Do not pay off your credit card debt with a HELOC. Most people will be back in the same situation with their credit card debt within two years."

But for those consumers who can manage their debt, when does it make sense to take out a home-equity loan, and when is it smarter to rely on a HELOC?