Use care when borrowing against home equity

Wed., Sept. 6, 2006

David Uffington King Features Syndicate

Before you borrow against the equity in your home, consider the benefits of two kinds of loans: the standard second mortgage (also called a home equity loan) and the HELOC, the home equity line of credit. There are benefits and disadvantages to both.

The standard second mortgage offers you something that the HELOC doesn’t: the security of knowing what your payments will be from the start of the loan until the end. With a HELOC, the interest rate is tied to the prime rate. That means your interest rate can change immediately.

With a second mortgage, the money you receive at closing is all you’re going to get. To get additional funds, you’d need to take out a new loan and incur extra expenses. With a HELOC, funds (within your loan amount) are there as soon as you need them. If you have a HELOC for $40,000 and you’ve spent $15,000, you still have $25,000 available to you over the life of the draw period.

Closing costs on a HELOC are considerably less than those on a second mortgage, as are the upfront costs.

There is one big caveat about using a HELOC: They’re much easier to get, and therefore much easier to abuse. The lender of a HELOC is more likely to give you an equity line of credit that’s greater than the equity you have in your house. The end result is that if you need to sell in a hurry you could be upside down: You won’t be able to sell for what you owe on your mortgage and the HELOC combined. With a standard second mortgage that’s less likely to happen because the existing equity is taken into consideration at the time of the loan.

If you’re interested in a HELOC, here are some things you should look for:

•No check, maintenance or usage fees. The lender is already making money on the loan.

•No appraisal fees.

•Pre-payment with no penalty.

•Interest-only payments, in case you need that later to reduce your monthly expenses.

•Conversion to a fixed-rate loan, in the event that interest rates start to rise past your comfort level.

•A cap on the interest rates over the life of the loan.

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