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5 Things to Remember When Getting a Home Equity Loan

Home equity loans and lines of credit are two ways you can obtain money for a lower interest rate than an unsecured loan. These loans come with considerably more interest than an unsecured loan, however, because they use your home as collateral. These five tips can help you make a well-informed financial decision.

1. Know How Much You Can Get

Before you begin shopping for a home equity loan or home equity line of credit, figure out how much equity you have in your home and how much you can use. Equity is more of a fluid amount. It changes with the market value as well as how much of your principal has been paid. You can roughly determine your equity by subtracting your mortgage balance, along with any other liens, from your house's current market value. Lenders will allow homeowners to borrow a percentage of their equity. Typically, this amount is approximately 80 percent.

2. Have a Plan for the Money

Before you start shopping for a loan or line of credit, know your purpose and have a well-calculated plan for how you will use the money. Don't give in to the temptation to borrow more than you need. This can cause you to incur unnecessary debt. If you are considering a loan or line of credit in order to make home improvements, you may want to first talk to a home inspector or real estate agent to determine how much they think you might recoup.

3. Home Equity Loans vs. Home Equity Lines of Credit

While both home equity loans and lines of credit allow you to use the equity in your home, one is a loan and one is a revolving line of credit. This line of credit works similarly to a credit card. You receive permission to use a certain amount of credit. You are charged interest on it as you use it. A loan is a one-time sum that you receive and on which you immediately begin to pay interest.

4. Avoid Adjustable Interest Rates If Possible

Many home equity lines of credit and some home equity loan rates are adjustable. These rates change with the market. Make a practical assessment of your monthly finances. Determine what interest rate you can afford. If you find one that's a little high but you think maybe by the time the interest rates adjust you'll be in a better financial state, hold off. Your home is the security in the loan. The last thing you want is to lose your home in the process of taking on a new loan. If you have the choice between a fixed and an adjustable rate, go with a fixed rate. In some cases, an adjustable interest rate can have its benefits, but with a home equity loan, it can just be adding more risk to the deal.

5. Beware of Penalties and Additional Payments

As you discuss the terms and conditions of loans and lines of credit, check to see if there aspects of your loan that might make it not as appealing. For instance, some loan agreements come with a balloon payment at the end of the life of the loan. This means that in addition to the monthly payments you'll make, you'll have one large payment due at the end of the loan. Other loans will penalize borrowers for paying the loan balance earlier than the loan conditions indicate. If you decide to prepay the loan, your lender will charge you a fee.

A home equity loan or line of credit allows you to borrow money at a lower interest rate than many unsecured loans. While it does have its advantages, it has its disadvantages as well. One of the most important factors to remember in consider such loans is that your house is used as collateral.