Jack M. Guttentag The Mortgage Professor

Shopping for a home equity line of credit (HELOC) is very different from shopping for a standard mortgage. In most respects, it is simpler -- if you know what you're doing.

A HELOC is always adjustable-rate. The negative aspect of this is that HELOCs provide borrowers with much less protection against interest rate increases than do standard adjustable-rate mortgages (ARMs).

The interest rate on a HELOC adjusts the first day of the month following a change in the prime rate, which could be just a few days. (Exceptions are those HELOCs with an introductory guaranteed rate, but these hold for only one to six months.)

Standard ARMs, in contrast, fix the rate at the beginning for periods ranging from one month to 10 years.

HELOCs have no limit on the size of a rate adjustment, and the only maximum rates are those set by state usury laws, which are generally 18 percent or higher. Some standard ARMs have rate-adjustment caps, and they all have lower maximum rates.

The good news is that HELOCs are easier to shop for. The major reason is that important features are the same from one lender to another. There may be some exceptions, but the interest rate on all of the HELOCs I have seen is tied to the prime rate.

In contrast, standard ARMs use a number of different indexes, which careful shoppers have to evaluate.

The critical feature of a HELOC that is not the same from one lender to another, and which should be the major focus of smart shoppers, is the margin. This is the amount that is added to the prime rate to determine the HELOC rate. Many if not most lenders do not volunteer the margin unless they are asked.

Here is what can happen when you don't ask: Borrower X, who provided me with his history, was offered an introductory rate of 4.5 percent for three months. He was told that after the three months the rate "would be based on the prime rate."

At the time the loan closed, the prime rate was 4 percent. Three months later, the prime rate was still 4 percent, but the rate on his loan was raised to 9.5 percent. It turned out that the margin, which the borrower never asked about, was 5.5 percent!

WARNING: Do not assume that the difference between your HELOC start rate and the prime rate is the margin. It may or may not be. Ask. Bear in mind, as well, that the margin varies with credit score, ratio of total mortgage debt to property value, documentation, and other factors. If the lender is advertising a margin, it is on their best deal. You need the margin on your deal.

Truth in Lending (TIL) on a HELOC is a travesty. It requires that borrowers be given an APR, which is the same as the interest rate. The borrower described above was given an APR of 4.5 percent early on, and when his rate jumped to 9.5 percent, he was told that his new APR was 9.5 percent. TIL does not require disclosure of the margin.

If the HELOC will be used to meet future contingencies rather than to refinance an existing mortgage, the shopper needs to know whether there is a minimum draw at closing, or a minimum average loan balance. Lenders don't make any money unless the HELOC is used, but they are not always forthcoming about this. Borrowers who are uncertain about future usage don't want to be forced to borrow money they won't need.

Upfront fees are the same types as on standard mortgages, except that HELOC lenders seldom charge points, and third-party fees tend to be small and are often paid by the lender.

There are some uniquely HELOC charges that you should factor in. These include an annual fee, usually $25-$75 and often waived the first year; and a cancellation fee, perhaps $350-$500, which is usually waived if the account stays open for three years.

Here is your checklist; make sure the figures you get apply to your deal.

1. Introductory rate and period
2. Margin
3. Minimum draw
4. Required average balance
5. Upfront lender fees
6. Upfront third-party fees
7. Annual fee
8. Cancellation fee