Home Equity Debt: Take the Good with the Bad

Forrest Gump once noted that life is like a box of chocolates-you never know what you're going to get. A home equity mortgage is a little different. You know that there are going to be pros and cons. Consider them all before you close on a loan.

If you're fortunate enough to have home equity after the recent plunge in real estate values, you have the flexibility of taking out a second mortgage. Whether you need home improvements or want to pay for a child's education or tuition, a home equity mortgage is still one of the best lending options around. Before you begin shopping for the best lender or home equity loan rate, consider the good and the bad features of a second mortgage.

Negative influence

Flexible options: There are two different kinds of second mortgages. The home equity loan provides you with a fixed-rate, fixed-term loan. It's a great option if you need to make a large, one-time expenditure, such as a home improvement. By choosing the fixed rate, you also avoid the turbulence of market changes.

The second option is a home equity line of credit (HELOC). This works like a credit card-you only pay interest on the amount that you borrow. It's very flexible, and can be used as a great source of emergency cash.

Rates: Your home equity loan rate will be lower than most credit cards and unsecured personal loans. When you consider the interest payments on high-rate cards, a low home equity rate can save you thousands of dollars.

Tax-deduction: The interest on a second mortgage is generally tax-deductible. Add tax dollars to your already low interest rate, and a credit card becomes an even costlier option.

Positive factors

Your home is collateral: As many victims of the subprime mortgage crisis will tell you, using your home for loan collateral carries some dangerous risk. If you're unable to make your payments on a loan, you could lose your home.

Long-term interest: Quick access to your home's equity is great. It's nice to have cash on hand when you need it. However, over the long haul, you'll be paying a lot of money in interest payments that you could have otherwise invested in growth assets, like mutual funds or a rental property.

Declining home values: Tap too much of your home equity and you may be stuck in your home in the event the real estate market declines. If you're over-leveraged, you may not be able to generate enough money from the sale of your home to afford an equal property elsewhere.

Homeowners who have retained home equity through the recent housing market bust should be thankful. They should also be cautious. If you're going to take out a home equity loan, make sure that you carefully consider the good points as well as the bad. It's a good loan, but only if you take it out for the right reasons.