Home equity loans can turn your house into a cash cow. Borrowing against your equity -- the value of your house above the mortgage debt -- offers better rates than using a credit card or consumer loans to make credit purchases. Your options include a home equity loan, also called a second mortgage; a home equity line of credit, or HELOC; or a cash-out refinance.
A second mortgage is the simplest type of home equity loan: you borrow a lump sum at a fixed interest rate and pay it back in monthly installments. This works well if you have a single big-ticket item to pay for, such as a major home-improvement project or consolidating credit-card bills. It's also a good choice if you don't trust the adjustable rates that come with a home equity line of credit.
A HELOC is a better choice if you're going to stretch out your spending over a year or more. If you have to pay for your child's tuition, for instance, you'll be writing the school a check periodically. With a HELOC, you don't withdraw money until you need to, and you pay interest only on what you take out. Interest rates often start lower than on lump-sum loans, but most HELOCs have adjustable rates that can potentially rise, making your payments less predictable.
A cash-out refinance combines a refi of your current mortgage with a home equity loan. If you have a $100,000 mortgage on a $200,000 house, for instance, you could take out a $150,000 mortgage, pay off the old loan and spend the extra $50,000 as you choose. This is a good option if you plan to refinance to a lower mortgage rate. If you don't want to let go of your current mortgage, a regular second mortgage may be a better choice.
Home equity loans offer better interest rates than other types of consumer credit, but in return, the lender gets the right to foreclose on your house. If you're thinking of borrowing against equity for a new car or a vacation cruise, your needs may be better served by not putting your house at risk -- you may want to find another source of funding or do without. The risk to borrowers is particularly high with a HELOC: it's easy to just borrow a small amount whenever your cash runs short and not notice the debt adding up.
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