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Home Equity Basics

Making Your Home's Equity Work for You

Your home is likely to be your most valuable asset, and in today's economic crunch, your home's equity might be able to provide a way to consolidate your outstanding debt.

There are two ways through which you can consolidate your debt by leveraging the equity in your home: a home equity line of credit and a home equity loan. While both methods are based on the amount of equity in your home that you currently own, there are key differences between the two options. Consumers looking to tap into their home's equity should be aware of these differences in order to determine which financing option is right for them.

A home equity line of credit and a home equity loan work is similar ways. Each is calculated based on the value of the equity in your home. When you apply for a home equity line of credit or loan, the lender first will determine your home's appraised value and then use a percentage of that value - generally 75 percent - as the basis for the amount of the credit line or loan. The lender then will subtract the amount you still owe on your mortgage from the adjusted value amount - the final number is the maximum amount the lender will approve for your home equity line of credit or loan.

How a Home Equity Line of Credit Works

A home equity line of credit works much like a credit card, with the credit limit based on your home's equity. Two key benefits of a home equity line of credit are this financing option often offers much lower interest rates than standard credit cards do and the interest paid on a home equity line of credit is tax deductable in most cases.

The annual percentage rate, or APR, for a home equity line of credit will vary from month to month, with the variable interest rate based on a fluctuating index, such as the prime rate. A home equity line of credit also can include other fees such as an annual maintenance fee or charges resulting non-use of the line of credit for an extended period of time.

After closing on a home equity line of credit, you will be able to draw money from the line of credit as needed - a big convenience if you are not sure how much money you will need up front. Additionally, you will be able to redraw from the line of credit again and again as you pay off what you previously withdrew.

Home equity lines of credit also offer smaller minimum payments than most other types of credit, and many lenders offer lines of credit with interest-only payment options.

How a Home Equity Loan Works

Known as a second mortgage, a home equity loan provides a fixed amount of money that the borrowers repays over a fixed period of time. In addition to home equity lines of credit, the interest paid on a home equity loan often is tax deductable as well.

While the APR for a home equity line of credit is variable, the APR for a home equity loan generally is a fixed interest rate. This interest rate often is higher than that of your first mortgage but will still be significantly lower than the interest rates of most personal loans or credit cards. With a home equity loan, you often will need to pay closing costs as well as points toward the low interest rate.

With home equity loans, funds are received in a single lump-sum payment, with a predetermined monthly payment that guarantees the loan will be paid in full by the end of the repayment period.

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