Choosing The Perfect Home Equity Loan

People draw on a home's equity when they need money, because home equity loan rates are significantly lower than those found for cash advances on credit cards. There's also significant tax savings, because interest on home equity loans of up to $100,000 is deductible on your income tax within certain limitations. While lower mortgage rates and tax breaks make home equity loans attractive, there are pros and cons to take into account before you apply.

Home Equity Loan: A Traditional Mortgage Twin

The first option is called a home equity loan of credit (HELOC), where the lender agrees to lend you a maximum amount of money within a certain time frame. It then issues a line of credit from which you can draw against, in the same manner that you would draw against a credit card. HELOCs have a variable interest rate, and may contain an interest-only provision that permits you to pay back only the interest for a specific period of time. This keeps payments low at first, but it doesn't rebuild your home's equity. Also, at the end of the interest-only period, payments will rise significantly.

HELOC: Access to money over time

The second option is a home equity loan, where the lender gives the borrower a lump sum. With these loans, the interest rate and the monthly payment are fixed. Payments are higher than an interest-only HELOC because they don't include principal. On the plus side, you get a chance to re-establish equity in your home. Borrowers looking for home improvement loans or debt consolidation often choose this option.

If you plan to borrow against the equity in your house, be sure that you know what purpose the money will be used for. In a way, shopping for loan is similar to shopping for clothing: Examine your options and then choose the one that's tailor-made for you.