Home Equity Basics: Do Your Homework Is buying a home right for you?

Many homeowners are taking equity out of their homes for a variety of purposes, such as to fund home improvements, reduce credit card debt, eliminate auto loans, help finance their family's education or just have some extra cash. A home equity loan is an attractive option because it usually offers certain tax advantages on interest deductions, whereas credit cards and auto loans do not. Plus, home equity loans typically offer lower interest rates than credit cards or auto loans. However "let the buyer beware" applies here as well, as home equity loans aren't right for everyone.

Home Equity Loans 101
Basically there are two ways to borrow your home equity: lump sum loans and home equity lines of credit. Lump sum loans work just like a second mortgage. You receive the full amount of the loan up front, and pay it back in fixed monthly installments over the life of the loan. Home equity lines of credit, on the other hand, work more like a predetermined line-of-credit. That is, once approved, you are allowed to "draw" off your loan amount up to your limit as you need it, usually by writing a check. Your monthly payment is usually a percentage of the total outstanding principle. In some cases, the loan or line amount is limited by the actual equity in your home.

Some important points to keep in mind
In recent years, more and more lenders are offering home equity lines of credit. The key benefit to home equity lines of credit is flexibility. Unlike a lump sum loan, with a home equity line of credit you only pay interest on the amount you actually borrow. However, certain types of home equity lines of credit require a minimum amount to be borrowed every time you draw on the line. You may be forced into taking an additional unneeded cash advance if you're not careful. What's more, some lenders offer an accompanying "credit card" with the home equity line of credit. So unless you have unusually strong willpower, having the credit card may be a dangerous temptation.

Is a home equity loan right for you?
While the thought of eliminating your credit card debt, paying off your car loan or building that extra bedroom is exciting, you should carefully consider all of your options before you decide to move forward with a home equity loan or line of credit. Additionally, it's a good idea to check your credit report and credit score before you apply. By knowing where your credit stands, you may be able to negotiate a better interest rate on a home equity loan.