Is a home equity loan right for you?

Understand home equity loans - how they work, their limits, and good uses.

It’s always a good idea to save for major purchases, but sometimes you can’t. In that case, a home equity loan is worth its weight in gold.

A home equity loan is a loan that is secured by the equity in your home. Typically, the loan limit is 75 to 85 percent of the difference between what you owe on your mortgage and what your house is worth at current market prices. It can be a one-time loan at a fixed rate of interest that you take out for a specific purpose. Alternatively, it can be a home equity line of credit (HELOC) with a pre-agreed ceiling and fluctuating interest rate that you can use for many things over a period of years, paying it down in between purchases.

The main virtue of home equity loans and lines of credit is that they carry a lower rate of interest than credit cards and unsecured consumer loans. Why? Because using your home equity as security reduces the risk of a loss for the bank.

Good uses for home equity loans include:

• debt consolidation
• home improvements and landscaping projects
• new cars
• tuition fees
• emergency repairs, purchases and replacements of appliances, roofs, furnaces and the like

Renovations and repairs that will enhance the value of your house are a particularly appropriate use for a home equity line of credit. So is consolidating consumer debts that carry a high interest rate, such as outstanding credit card balances that you find hard to pay. A long-term, fixed-rate home equity loan allows you to pay off all your cards in one fell swoop, and leaves you with one predictable monthly payment you can manage – as long as you resist the urge to start charging things again.

It’s best to be conservative about how you use a home equity loan. In particular, think twice about buying stocks or starting a new business venture with the money. If the stock price goes through the floor or the business loses money, your home is at risk.

It’s also wise to be conservative about how much you borrow against your home. Some lenders may be willing to advance you 90 percent or more of the value of your equity. If house prices in your area fall, so will your home equity and your borrowing limit. Your lender may then call your loan, asking you to pay back any borrowed funds in excess of your new, lower, limit.

Before borrowing, make sure you research the kinds of home equity loans that are available, and ask your lender to explain the details of how they work.