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Home Equity - What It Is, How to Use It

Remember that piggy bank you had as a kid? You'd put money in it, and eventually you'd bust it open when you needed the cash that you saved.

A home equity loan is much like this. As you pay back the loan on your house, the bank owns less of the house, and you own more of it -- the part you own is called equity, and having it grow is called "building equity." 

You may take a loan out using the home equity as collateral. This is termed a "home equity loan." It used to be known as a "second mortgage," but the bank marketers correctly figured that if they focused on the bright side -- owning more of your home -- they'd make the practice of borrowing against it more acceptable. And they were right.

Tapping the equity in your home can often make more sense than other forms of borrowing.

In most instances, the interest paid on the home equity loan is tax deductible, which makes these types of loans more attractive. The interest rates on these loans are also much lower than conventional loans, so it can make a lot of financial sense to use this money instead of borrowing at prime rates. It's become much more common for people to use home equity loans to make major house repairs, pay college fees for kids, and pay off high-interest-rate credit cards.

Most of us can and do run up credit card debt without knowing exactly what we have spent on. Credit card companies make their money off the interest you pay on the money you owe to the credit card. This interest is not tax deductible and the rates can and usually are very high.

A lot of people find themselves with far more credit card debt than they can handle. If you are in this situation, start arranging to refinance the debt into a home equity loan. Remember that by refinancing you are not adding or subtracting money from what you owe, but you are simply moving the debt to a lower interest rate loan. You may have several debts and can consolidate them into a one-home equity loan and thus one monthly payment.

Note that a home equity loan is a fixed amount borrowed over a fixed term usually no more than five years.

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June, 2012

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