Home Equity Loans & Lines of Credit - How They Work

Whether you need a down payment on a car, a new computer, or are experiencing life changes such as a new addition to your family or are financing a business or education, you can use the equity in your home to obtain the money that you need. The equity in your home is the difference between your home's market value and the amount you owe on your home.

Home Equity Loans Basics

Home equity loans, also refereed to as a second mortgage loan or a cash-out refinancing loan, are common place. The advantages to these loans are that they usually have lower interest rates than consumer loans, have fixed payments that are predictable, are backed by your home's equity, and in most cases, are tax deductible.

The biggest disadvantage to home equity loans is that you absolutely can not default on this loan in any way, or you may lose you home. Another disadvantage is that you may use up the equity that you have built in your home, which results in a longer pay off period for your home.

Home Equity Line of Credit Basics

A home equity line of credit is revolving credit that you can obtain by using your home as collateral. This option is very similar to obtaining a new, shiny credit card with a very large limit: the equity on your home. The term is defined by a draw period that allows you to borrow money from the line. The payment each month is based upon the outstanding balance owed. As payments are applied to principal, your available credit increases accordingly.

The biggest advantage is that the interest rate you pay on the average home equity line of credit is generally lower than the interest rate you will pay on a credit card or other type of non-secured debt. Also, you can usually deduct the interest you pay, but be sure to consult with a tax counselor concerning the deductibility of interest.

The most notable disadvantage to a home equity line of credit is that your home is used as security. If you default on your payments you could lose your home. Also, if you decide to sell your home before paying off the line of credit in full, the amount will be paid from the sale price.

By Carrie Reeder