A traditional home equity loan is secured by the equity you have built up in your home. Therefore taking such a loan can be a wise choice for meeting some financial needs, because it offers the lower interest rates of a secured loan and may have tax-deductible interest.

The amount you can borrow on a home equity loan is, of course, limited by your actual equity. Equity is calculated by subtracting the unpaid balance of your mortgage from the fair market value of your home. Lenders will offer some percentage of equity as a loan amount, usually 75% to 90%.

There are two basic types of home equity loans: lump sum loans which work like second mortgages, or home equity credit lines, which work more like credit cards.

Up-Front Loans Can Cover Big-Ticket Purchases

With an up-front home equity loan, you receive the full amount of the loan when it is opened, and pay it back in fixed monthly installments over the life of the loan. Your payments may be fully amortized, meaning that you pay back interest and principal as you go along, or may consist of mostly or only interest, with a "balloon" payment of the remaining money owed at the end of the loan.

An up-front loan like this can be a good for:

• Home improvements
• Debt consolidation
• Buying a car
• Paying large, unexpected bills such as emergency medical expenses

Home Equity Lines Allow You to Borrow Only What You Need

With a home equity credit line, you have a maximum loan amount available that you can draw on as you need it, usually by writing a check. Your monthly payment is usually a percentage of the total outstanding principle.

The particular benefit of home equity lines of credit, as opposed to up-front loans, is their flexibility. A credit line like this can be a good way to help pay for a child's education, for example, because you can borrow-and pay interest on-each year's costs only as they arise. With an up-front loan, you would pay interest on all the money from the very beginning.

Because this flexibility is the key benefit, try to avoid a home equity line that specifies a certain minimum be borrowed every time you draw on the line or that requires an initial cash advance you do not need. Also, unless you have very strong willpower, don't take the "credit card" that some lenders may offer with a home equity line. Carrying it around in your wallet may make drawing on the line too easy and encourage you to borrow more freely than you should.

Examine All Your Options Before Borrowing Against Your Home

With interest rates that are typically lower than many credit cards, a home equity loan can be the best way to finance a large purchase or cover an unexpected expense. But home equity loans and credit lines are more expensive than first mortgages, and may be more expensive than other financing options such as an auto loan or subsidized student loan.

When you consider a home equity loan, think through these issues:

• Does this home equity loan offer the lowest interest I can find to finance this purchase?
• Am I attracted by an introductory rate that is much better than the long-term rate of the loan?
• Will my interest be tax deductible? (The only way to be sure is by consulting a tax advisor.)
• Is the risk of putting my home on the line a worthwhile tradeoff to achieve this financial goal?

If a home equity loan is in fact the right financial tool for you, rest assured that you are in good company. These loans and lines of credit are among the most popular in the mortgage industry. Just remember that it is up to you to examine all your options and borrow sensibly.

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