Home Equity Loans - A Powerful Financial Tool

The equity in your home can be a tool in managing your finances. Home equity, the value of your home minus your existing mortgage, can serve as collateral for additional borrowing. While there are risks involved (as with any borrowing), home equity loans usually offer a low interest rate and can be a good option for credit needs.

How does a home equity loan work?

Most institutions view home equity as good collateral and are often willing to lend you money against it. The amount depends on the amount of equity in your home and your credit profile. A typical amount is up to 80 percent of the current value of your home. That 80 percent includes the amount left on the first mortgage and any loans secured by your home as collateral.

The interest rate charged will usually be variable and tied to a published index, such as the prime rate. Be careful of low "teaser" rates that increase after an introductory period. Carefully read the rate details of any loan you’re considering.

Most home equity loans require minimum payments paid in regular installments. Others offer interest-only payments with specifications for when the loan has to be paid in full. Read each document carefully before signing.

Attractions of Home Equity Loans

Convenience — Easy applications are typical of home equity lending. The process is often simpler than if you were applying for a new mortgage. Once approved, the commitment acts like a line of credit. You do not have to borrow the entire amount at once.

Interest rates — Interest rates charged on home equity loans are usually higher than rates on first mortgages, but less than rates on credit cards. Using the proceeds of a home equity loan to pay off credit card debt usually saves money.

Flexible uses — Home equity loan or line of credit funds can be used as needed. Typical uses include paying off debt, buying a car or home renovations. Compare rates on an auto loan and a home equity loan the next time you are financing a car. The difference may surprise you.

Beware of the risks

Borrowing against the equity in your home should be considered carefully. If the loan cannot be repaid, your home serves as collateral and may be taken to pay off the loan. Most borrowers use home equity loans for "conservative" purposes and avoid making risky investments or extravagant spending with the funds.

Read and understand all the details before signing. Loan documents can be confusing and can mask the costs and risks.