Which Type of Home Equity Loan is Best for You?

If you decide to apply for a home equity loan, look for the plan that best meets your particular needs.  Look carefully at the home equity loan agreement and examine the terms and conditions of various plans, including the annual percentage rate (APR) and the costs you will pay to take out the home equity loan.  The disclosed APR will not reflect the closing costs and other fees and charges, so you'll need to compare these costs, as well as the APR's, among different lenders who offer hom equity loans and home equity lines of credit. 

Should you pick the traditional home equity second mortgage type of loan or the home equity line of credit?

Financial experts advise you to choose a home equity line of credit rather than a traditional home equity loan (second mortgage) when you plan to use the loan for costs that are recurring, such as medical bills, tuition costs or an extended home improvement project.  The key words are "extended" or "recurring" -- when you plan to use the funds to pay extended, or recurring costs -- a home equity line of credit is the best choice in most circumstances. 

A traditional home equity loan, or second mortgage is advisable when you require a one time payment, rather than a series of recurring payments.  Therefore, second mortgages are good choices for debt consolidation, home improvements or capital for starting a new business.

In deciding which type of loan best suits your needs, consider the costs under the two alternatives.  Look at the APR and other charges. You cannot, however, simply compare the APR for a traditional mortgage loan with the APR for a home equity line because the APRs are figured differently.  The APR for a traditional mortgage takes into account the interest rate charged plus points and other finance charges.  The APR for a home equity line is based on the periodic interest rate alone.  It does not include points or other charges.
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Home Equity Loan Pitfalls

Although home equity loans can be used to pay off debt, fund a college education, or pay for a nice vacation, there are certain things you should be aware of, such as the following:

(1)  Watch out for home equity loans that offer a very low introductory rate that increases dramatically to a very high regular rate;

(2)  Find out if the loan comes with prepayment penalties. You might want to pay off the debt as fast as possible and don't want prepayment provisions to prevent you from doing this;

(3)  Variable rate loans must have a cap that sets an upper limit that the interest rate cannot rise above.  If this cap is ever reached, the lender has the right to shut down the line of credit; and

(4)  A lender can call in the loan and demand full repayment if your home loses a significant amount of value.  Similarly, if your income decreases or your financial health suffers, the lender can cancel a home equity line of credit.

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