Section 1:
Home equity loans: pros and cons
First, let’s define the difference between a home equity loan and a home equity line of credit.

• A home equity loan is closed-end credit. You get all your money up front and make fixed payments (usually) for a determined amount of time (the term) until the loan is paid off.
• A home equity line of credit is open-end credit. You’re approved for a certain amount of money and you’ll probably have a variable rate. You can take advances for various amounts of money up to your pre-established credit limit. You make payments (including interest) only when you have outstanding balances against your line of credit. The APR of each advance is determined by the agreement of your contract. Generally, with a variable rate loan, the rate is tied to an index and can go as high as 17%.

A home equity loan can be a great way to eliminate unsecured debt, pay for college tuition, buy a car, improve your home and more. With current low rates on mortgage lending, home equity loans are a good deal right now and could improve your financial stability.

Or, it can be a way to postpone the inevitable if you don’t clean up your act. If you take a home equity loan to consolidate high interest debt, like credit cards, and don’t change your spending habits, you’ll end up worse off than ever.

It all depends on the borrower.

Having a home equity line of credit is handy to have during an emergency, and you only pay interest on the money you spend. By getting equity lines when things are going well, you’ll have something to fall back on if you lose your job, if there is an extended illness or if there are other pressing emergency situations.

Avoid frivolous purchases, however, such as a vacation or a big screen television. It’ll cost you a lot more over the term of the loan, especially if you have it stretched out over 10- to 20-year terms. If you buy a television for $3,200 today on your equity line and stretch out the payments for 10 years at 5.4%, you will have paid $4,148 for your television. And will it still be working? Reserve your home equity loan spending for major purchases and items that are likely to last for years.

125s. Some lenders are willing to finance as much as 125% of your home’s actual market value. This is called a 125 and is defined as a high loan-to-value home equity loan. Look at this example of how the dollars play out.

What happens if you fall behind on your loan? Not only could you lose your home, but you would also owe any or all of the $25,000 that you have not paid back.

So ask yourself carefully:

1. Do I really need a home equity loan?
2. Can I afford to take on more debt?
3. Do I really know what my monthly obligations are?
4. Will I be able to make the additional monthly payment?

And finally, and most importantly, if you’re using a home equity loan to consolidate and replace high interest debts, such as credit card debt:

5. Do I have the discipline to change my spending habits and not run up those high interest cards again?

You may have a lot of equity built up in your home, but you will be taking on more debt. You need to be very familiar with your monthly obligations. If you can’t make the monthly payments, you may find yourself in a very difficult situation: You could lose your home.

If you still think you can afford it, read on to find out how to shop for a loan.