A home equity loan, popularly known as second mortgage, is a financial tool that allows homeowners to borrow funds against their home’s value. Lately, home equity loans have become a popular means to arrange liquid cash for big expenses such as large-scale renovation, college education, payment of credit card or medical bills, overseas vacation and so forth.

While the tax deductions that home equity loans once enjoyed no longer apply, these loans are still preferred for their low interest rates compared to other types of loans such as consumer loans and credit cards. If you’re planning to apply for a home equity loan, the following information will serve as a quick and handy guide to the concept.

Types of home equity loans

When you go looking for a loan against your home’s equity, you’ll find that there are two types of loans, based on how the payment is dispersed by the lender. Here’s a brief explanation of both.

Fixed-rate home equity loans

Fixed rate second mortgage loans are offered as a one-time lump-sum payment. The borrower agrees to pay back the sum over a predetermined duration at a fixed rate of interest. The greatest advantage of this type of loan is that there is no change in the interest rate and the monthly payment during the life of the loan.

Home equity Line of Credit

This type of loan allows the borrower to withdraw funds as and when needed, using a credit card or checks issued by the lender. A spending limit is applied based on the total sum approved.

While both types of loans have a fixed term (that is, they need to be repaid within a specified timeframe), LOC home equity loans have a variable interest rate. Consequently, the monthly payment varies based on the sum withdrawn and the present interest rate.

A condition common to both types of equity loans is that if you decide to sell your house before the loan is repaid, you’ll need to first pay off the outstanding amount in full.

Should you take out a home equity loan?

Using your home’s equity to improve your cash flow has its risks. Think it through before taking a decision, and if you decide to go ahead, remember to apply for a home equity loan only from a trusted and reputable lender.

When making the decision, consider important factors such as your current debt, financial condition, family income and age. For instance, if you’re nearing retirement age, it may be better to consider other options. If, on the other hand, you have a stable income and know that you will be able to repay the entire sum during the loan term, taking a home equity loan may be a better choice owing to its low interest rates compared to personal loans.

While researching lending companies and credit unions, it may be a good idea to get more than one quote and compare terms and conditions, closing fees and interest rates before making a decision.