Choosing the Right Home Equity Loan Option

Are you bewildered by the staggering number of loans designed to let you tap into your equity? The options seem endless, but they don't have to be "too much of a good thing." The first step toward choosing the right home equity loan option is deciding how you want the money. The following loan choices are described in terms of whether you want money in a lump sum (ideal for short-term needs like home improvement projects or a vacation), or smaller, incremental withdrawals (perfect for college tuition payments).

Cash-Out Refinancing-Lump sum

If you're looking for a lump sum of money, and rates on first mortgages are low, the cash-out refinance is a great call. This involves refinancing your first mortgage and cashing-out a lump sum of equity. In this case, closing costs are higher than with a second mortgage. However, if rates for first mortgages are lower than what you currently hold, you could wind up with a hat trick: A lower monthly payment, long-term interest savings, and the cash you need. With a hat trick like that, your financial life won't be skating on thin ice.

Home Equity Loan-Lump sum

The home equity loan has a fixed rate and term, and, like its sister, the home equity line of credit (HELOC), is considered a "second mortgage." Because first mortgages must be satisfied "first," if a bank is forced to sell a house because of a loan default, lenders charge a slightly higher rate for second mortgages. However, if your first mortgage is at a low rate, the home equity loan might be just the ticket for a lump sum cash withdrawal.

Home Equity Line of Credit (HELOC)-Incremental withdrawals

A HELOC, like the home equity loan, carries a higher interest rate than a first mortgage. It's a popular choice for people who are looking to tap their equity for regular payments that spread out over time. Borrowers who need to make college tuition payments choose HELOCs because they work in a similar manner to credit cards: You have a pre-set credit limit, which you may draw upon when you need it. You're only charged interest on the amount you tap, and the rate is generally tied to the prime lending rate, which is relatively stable.

These are the three most popular ways to transform the equity in your home into cash. All you need to do is decide whether you want a lump sum or incremental withdrawals. Once you make that choice, refer to the general guidelines listed above. It should narrow down the vast universe of lending options to a home equity loan that meets all your needs.