The value of your home minus the amount you owe on the mortgage is called equity, and for many homeowners this is where they turn when they find themselves in need of some cash.  Taking a loan out against the equity in your home is referred to as a second mortgage, and this is common practice for many people who need to make repairs on their homes or other home improvements.  Some even utilize equity for debt consolidation purposes.

The problems begin, however, when people view equity as free money and spend it accordingly.  One loan product, which makes this sort of mentality particularly possible, is the home equity line of credit.  In theory, this sort of loan makes sense for people who are having a lot of work done on their home and need ready access to the funds in the form of a checkbook or credit card to pay contractors.  The account is a revolving account, much like a credit card, which offers an available balance to the borrower based on the equity of the home.  As the balance owed is paid down, the available balance goes back up. 

Issues arise when homeowners get these sorts of credit lines with no particular objective in mind.  Sure, there are some responsible homeowners who will open up a line of credit on their equity as an emergency fund and never touch the money except in the case of emergencies or major home repairs, but then there are other homeowners who use their line of credit as they would use a checking account or credit card.  Equity lines of credit were certainly not designed to fund routine shopping trips or dinners out.  It is imperative to remember that this debt is against your home, and failure to pay will not result in hassles from creditors like it would with a regular credit line, but rather will result in foreclosure of your home.  Money borrowed using an equity line of credit should be used only when there is no other option.

Some experts would disagree with these ideas, stating that since interest paid on home equity loans can be tax deductible just like a first mortgage then a HELOC should be utilized for everything from bill consolidation to auto purchases.  The problem with this thinking is that since a home equity line of credit is revolving it is entirely too easy to get carries away and spend beyond your means.  What happens if the value of your home fails to appreciate, or worse yet, if it depreciates? If you have maxed out your home equity line of credit, then you will be in the highly unenviable position of owing more on your cumulative mortgages than your home is worth.  This means that if you go to sell the home, you may wind up actually taking a loss on the sale instead of coming away from the deal with a handsome profit.

Another issue with home equity lines of credit is that the payments are usually set at variable interest rates.  This means that even if the money is borrowed initially at a very attractive interest rate, the rate will probably not stay at this rate.  Most lenders base their interest rates loosely on the federal government’s prime interest rate, so if this prime rate goes up then the interest rate on the variable equity line of credit will go up too.  For some families who are already living paycheck-to-paycheck, it can be devastating when payments go up unexpectedly.

If you must tap into your home equity for some cash you should first consider a fixed rate home equity loan.  This gives you exactly the amount of cash you need and does not allow you more money that may wind up being spent frivolously.  If you do indeed decide upon a home equity line of credit you must take care to not use the available money as though it were free money; always keep in mind that you are borrowing against your home.  Yes, it can be fun to indulge in a shopping trip or take a fabulous vacation, but do you really want to still be paying for these things long after the clothes have worn out and the vacation is nothing but a distant memory? Equity in your home is certainly not free money, and should only be utilized when absolutely necessary.

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