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Understanding Home Equity Loans

As a homeowner, you may be able to borrow against the equity in your home. The equity is the difference between the property's market value and the Home Equityoutstanding loan balance. These types of loans have become increasingly popular because the interest rate is usually lower when you borrow against real estate. And the interest on a home equity loan is mostly tax deductible (always consult with a tax expert before deducting any home equity interest on your income tax return).

Home equity loans usually come in two varieties: the traditional "second mortgage," and a home equity line of credit. Here is how they work:

  • Second mortgages - Just like your first mortgage, it is a loan that uses your house as a guarantee that you will make your payments. While there are many advantages of getting a second mortgage as a home equity loan, you need to remember that you are exposing yourself to the risk of foreclosure if you should run into any unexpected financial problems, such as a job loss.

  • Home equity line of credit - These types of loans have increased in popularity since the late 1980s, when the deduction for interest on consumer loans were phased out by the Internal Revenue Service. They work similarly to a credit card or revolving line of credit. Your bank provides you with a checkbook that is used to draw against your line of credit. You can write checks for major purchases, such as a car, or medical expenses, or just draw out some cash and go on vacation. Equity lines of credit should be used wisely, because your home is on the line. If you fail to repay your equity loan, you may end up losing your house.
If you are considering taking out a home equity loan, shop around and look for the best rates and repayment plans that are available. And remember that you are putting your home on the line, so treat a home equity loan with the respect that it deserves.

See also: Mortgage Refinancing, Credit Cards, and Managing Debt

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