Not All Home Equity Loans Are Created Equal

A home equity loan is also called a second mortgage. They use the amount of equity, that is, the value of the home you own in excess of your first mortgage loan balance, as collateral. They can be more difficult to get these days with dropping home prices wiping out large amounts of equity across the US, but even with the subprime crisis and recession, with consistent payments and/or a sufficient down payment this resource may still be available to you. You will also need a decent credit history to qualify.

Not All Home Equity Loans Are Created EqualThere are two main types of home equity loans. The first is a lump–sum loan, which mimics a first mortgage but will have a higher interest rate. These kinds of loans are often used for paying off higher–interest credit card balances or for major projects where the price is known, such as home improvements and unexpected medical bills. Interest is tax–deductible, so that helps mitigate some of the expense.

The other type of home equity loan is the home equity line of credit (HELOC). These operate like secured credit cards, and sometimes such cards are even issued to the account. These loans have variable interest rates, so they carry greater risk. They have a set term like other types of home loans. Once the term is up, any remaining balance must be paid in full. This type of loan, by being secured, will often have a lower interest rate than credit cards, and what interest rate there is will be tax–deductible in most places. However, this type of lending has experienced a freeze of late, causing some real problems for people. Indeed, freezes of existing accounts have even precipitated lawsuits. This type of lending, while it can be very useful, is very hard to get since the crisis in the financial world. In addition, this variant of equity loan is often a recourse loan, which is to say that they can still come after you for the money even after foreclosure.

Both of these types of equity loans can be useful, but it's important to note that both will add to your debt substantially and increase your monthly payments. Make sure you're ready first! Also keep in mind whether the purposes you are taking out the loan for really make sense. Want to increase the value of your home by using a home equity loan to make improvements? Make sure they're the right ones. A swimming pool might be fun for you, but if your goal is to eventually sell the home for more money then you'd be better off redoing the kitchen or bathrooms. If you're taking out the loan to pay off the college bill of your children, what are the implications for your retirement?

Beware of loans that offer to give you more money than your equity, too! The amount over is unsecured, so your costs will be higher. The interest on the excess amount is also not tax–deductible. With any debt, but especially something like this, make sure there really is no other option first.

Home equity loans can get you more money in a more cost effective way than unsecured debt ever could. However, debt that's secured means debt that could put your collateral in jeopardy. In this case, your collateral is your home. So be wise when taking sure steps towards this option.