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Using Home Equity Loans

The “equity” in your home is the difference between the market value of your home and the balance you owe on your mortgage loan(s). Many lenders will loan you up to 85 percent of your equity, but your home is collateral, so if you fail to make payments on time, you can lose your home.

Home equity loans have lower interest rates than bank and store credit cards and consumer installments loans because they are “secured” by your home. One of the benefits of the home equity loan is that you may be able to take the interest payments as an itemized income tax deduction.

There are two types of home equity loans:

  • A “second” mortgage usually has a fixed term, fixed interest rate and fixed monthly payments.
  • A home equity “line of credit” is “revolving” credit, like a credit card. It usually has a variable interest rate and may have a large “balloon” payment due at the end of the loan. You can write checks against the loan amount as you need to or access the loan with a special credit card.

Different lenders offer home equity loans with widely varying terms. Before you apply, ask several lenders to give you in writing the following information on their loans:

  • Whether the loan has a limited “draw period” during which you can withdraw money against your line of credit.
  • When you will be required to repay the full amount.
  • The annual percentage rate (APR). On a variable-rate line of credit, the APR covers only the interest rate; other fees are charged separately. On a second mortgage, the APR includes other fees.
  • All upfront and continuing fees not included in the APR.
  • Monthly payment amount. For a variable-rate loan, you’ll need to know the “worst-case” scenario, that is, how high the interest rate can go, how soon it can rise that high and how high the monthly payment can go.
  • Repayment terms during and at the end of the loan.

Compare this information for loans from several lenders and choose the loan that best meets your needs. Lenders will compete for your business, so negotiate to get a better deal if you can.

If a balloon payment is involved, be sure you understand exactly how it works. On some loans, for example, monthly payments cover only interest costs, not the loan principal. If you borrow $10,000 and make periodic payments that only cover interest, you may have to make a final payment of $10,000. If you are unable to pay that amount when the final payment is due, you could lose your home.

Because you can lose your home if you don’t make equity loan payments as agreed, you should not use an equity loan for ongoing day-to-day expenses. Use it only for major one-time expenses like home improvement projects, education or medical bills.

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