Differences in Home Equity Mortgage Loans

If you have a bad credit card habit, need to pay for an education, or finance medical treatment, you may be considering a home equity loan. These loans come in two forms and one may be better suited to your situation than the other.

Home equity loans are collateralized by your home, with terms ranging from 5 to 30 years, and are generally tax deductible if you itemize your deductions on a Schedule A. There are two main types of home equity mortgage loans--fixed rate loans and lines of credit. Each works differently and is appropriate for different situations.

Fixed Rate Loans

A fixed rate loan delivers a lump sum to you, which you repay with monthly installments for a set number of years. The interest rate and the payment remain constant over the life of the loan. The rate on a fixed home equity is generally higher than that of a first mortgage but usually lower than credit cards or other consumer financing. A fixed rate home equity loan or second mortgage offers you the advantage of stability--you know exactly what your payment and interest rate will be each month. If you need a large sum to pay off lots of debt, finance a home improvement effort, or pay for an emergency medical procedure, the fixed rate mortgage is probably your best bet.

Home Equity Lines of Credit (HELOCs)

A HELOC is a revolving line of credit similar to a credit card. You are approved for a credit limit, and can use as much or as little of that as you need. Your payment is determined by the interest rate, which can change, and the amount borrowed. The HELOC must be paid in full at the end of its term. HELOCs can be broken into two phases, a drawing phase, when you tap into your credit, and a repayment phase, when you have to make payments but aren't allowed to increase your balance. HELOCs can be great hedges against emergencies--you can prevent bad credit and financial problems later by getting approved for a HELOC when things are going well. If you have wildly fluctuating income, having a HELOC in place could help you avert a financial or credit crisis. Home equity mortgage loans can be great tools to bail you out of financial trouble or bad credit problems, or as a backup source of funds to help you prevent a financial crisis. It makes sense to investigate them even before you need them.

By Gina Pogol
Mortgage Credit Problems Columnist