Banking on home equity

September 1, 2007

You've been thinking about expanding your practice, or perhaps you have a child entering college, or maybe you just have a heavy debt load, and debt consolidation looks like a sensible way to lighten it.

You've been thinking about expanding your practice, or perhaps you have a child entering college, or maybe you just have a heavy debt load, and debt consolidation looks like a sensible way to lighten it.

Whatever the reason, you need to get your hands on a sizable hunk of money. A second mortgage on your home could be a relatively easy way to come up with all that cash. Second mortgages offer several advantages for homeowners in need of a substantial loan.

If you're considering using the equity in your home to borrow money, it's important to understand the differences between two basic types of home equity credit: a home equity loan (second mortgage) and a home equity line.

A home equity loan is an additional (second) mortgage loan, while an equity line works much as a credit card does.

A traditional second mortgage loan provides your money in one lump sum; a home equity line of credit allows you to obtain cash on an ongoing basis, as you need it.

Therefore, you should use an equity loan when you need all the money up front. An equity line may be more advantageous if you have an ongoing need for money, such as college tuition payments.

Another consideration when choosing between home equity loans and equity lines is your monthly payment. Home equity loans usually have fixed interest rates and fixed payment amounts, while most home equity lines are of the adjustable-rate type - if the interest rate goes up, so will your monthly payment. So, if you like things nice and predictable, a second mortgage may be your best choice.

Although second mortgage interest will usually be a bit higher than first mortgage interest, it will likely be lower than other forms of financing. That makes borrowing money against your home one of the alternatives you should consider when you need a relatively large amount of cash. In addition, mortgage interest is usually tax-deductible (be sure to check with your accountant).

Keep in mind, however, that second mortgages have their downside, as well. Any type of home equity credit requires you to use your home as collateral. If business conditions worsen and you are late or cannot make your monthly payments, you risk losing your home. In addition, some second mortgage loans require a large final (balloon) payment that may require you to borrow more money to close out the loan. If you sell your home while your second mortgage is still outstanding, most plans will require you to pay off the remaining balance of your loan at that time.

Despite these risks, second mortgages remain one of the most popular forms of emergency financing for both business and personal purposes. Once you decide that a second mortgage loan is the way to go, you'll need to take a careful look at several considerations.

In terms of interest

Among the most important considerations are the interest rate and its terms.

If you take out a fixed-rate second mortgage loan, the interest rate will usually be set for the life of the loan. However, many lenders offer variable rate mortgages, also known as adjustable rate mortgages or ARMs. These provide for periodic interest rate adjustments to accommodate changes in the overall economy. If your contract allows the mortgage company to adjust or change the interest rate, be sure you understand under what circumstance the lender has the right to make a change, whether there are any limits on how much the interest or payments can change, and how often changes may be made. You should also have a clear understanding of what basis the lender will use to determine the new rate of interest.