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How to Know if You Should Get a Home Equity Loan

Did you know that you can draw on the money you've paid down on your pad if you need to free up some cash? Here are the basics.

A home equity loan doesn't entitle you to free money, but it can be a smart decision for some homeowners. Get the facts:

Home Equity Loans

When you get a home equity loan, you’re borrowing against the equity you’ve built in your home. In general, you can borrow up to 80 percent of your equity. Say you owe $200K on a home that appraised at $250K. Your equity is $50K. You would likely be able to borrow up to $40K, or 80 percent of $50K. This is how it boils down: You borrow a lump sum (at a fixed or variable rate), and pay it off just like your mortgage. There will also be fees and closing costs.

Home Equity Lines of Credit

You can also get a HELOC, or home equity line of credit. It basically works like a credit card. You have a fixed credit line and can borrow up to that amount (usually they cap them at $50K). You may get offered "teaser rates" that will expire, so read the fine print.

The Pros of Borrowing

With home equity loans, you can often borrow more money at a lower interest rate than other types of loans. It’s also interest deductible up to $100K. But be smart. “The money has to be used for a necessity, like a capital improvement that will increase the long-term value of your home,” says Carol Buchman, a CFP and CPA in New York City. A new hot tub or plasma TV doesn’t count.
You can also use the cash to pay down extreme credit card debt. “If the interest you have to pay on the line of home equity is less than what the credit card is charging, and you’ve tried to negotiate with them to no avail, you can use the equity to pay it down,” says Buchman. But don't create a revolving door of debt -- really look at the numbers.

The Dangers of Borrowing

Even if your home’s value decreases, the amount you owe on your loan is still set in stone. Also, if you miss payments, you risk going into foreclosure (yep, even if you’ve made all payments on your main mortgage). Plus, the fact that you can use it like a credit card can lead to out-of-control spending.

How to Get a Loan

When to get a line of credit depends on interest rates. Buchman suggests negotiating with contractors and pick someone for the job. Once you know what it’s going to cost, shop around at banks and check out LendingTree.com for the best rates.

Nestpert Carol Buchman, a CFP and CPA in New York City

-- Alonna Friedman

See More: Money Q&A , Mortgages