Are you drowned in debt? Taking out a second mortgage once meant you were in financial trouble. Today, people take out home equity loans, which is another name for a second mortgage, to pay for everything from home renovations, weddings, and other loans. Although some people consider it as a smart way to borrow money, this type of loan can be hazardous to your finances.

Equity is the amount left over after you subtract your home loan from what your house is worth.

People think this type of loan is a great deal because you get better terms when pledging your home rather than an unsecured credit card or used car. Rising real estate values have created more equity in homes, allowing people to borrow even more money.

But borrowing against your home may put you so far in debt that you’ll never own your home free and clear from liens. And consider these other pitfalls. Interest rates usually are not fixed so they can change as the economy changes. That means you have no control over future costs. And if the economy is bad, the lender can demand payment or a renegotiation of terms. On the other hand, if something happens to you and you can’t pay, the lender can foreclose and sell your home to collect the loan.

So you need to consider this type of loan carefully and decide whether it’s worth the risk of losing your home. In most cases, you’re better off keeping your home equity and working to pay off the remaining mortgage.

If you do have serious reason to borrow against your home, you can do it in one of three ways:

Installments. The basic home equity loan is just a normal installment loan with a fixed interest rate and regular payments. It’s a good way to borrow because there is built-in discipline. You take care of a set amount of debt over a set period of time and at a set interest rate.

Line of Credit. A home equity line of credit is a revolving line of credit just like a credit card. You set it up for a maximum of amount and usually for a certain time period. You only have to borrow as much as you need at a time, then you can pay some or all of it off, and borrow it back again. That’s how a revolving line of credit works. You’ll probably get a lower interest rate but it will float up and down with current economic conditions.

However, remember this. Never ever use a line of credit to replace your out-of-control credit card debt. If you can’t manage your spending with a credit card, you’re likely to get into even more trouble with the extra freedom of a home equity loan.

A line of credit is good for loans that don’t require full payment all at the same time, like a long-term remodeling project or college education expenses. It’s also nice to have it ready for emergencies like unemployment or hospitalization.

It’s very important to have a payoff plan for a line of credit. You don’t want selling your home to be the only way of getting rid of the debt.

Refinancing. The third option is to refinance your original home loan. Pay off your first mortgage and write a new one for a larger amount, using the leftover cash instead of getting a separate loan. But that’s only a good idea when current interest rates are lower than your old loan. In a rising rate situation, you’re better off with a second mortgage.

Watch out for closing costs and other fees on both first and second mortgage loans. They are, after all, real estate loans that can require surveys, appraisals, and other documentation. Make sure the convenience and the interest savings are more than the extra fees. Sometimes, you can find lenders so eager to make home equity loans that they will waive the fees or offer other incentives.

With the current economic downturn, which caused a huge drop in home values, I guess this is not the right time to refinance loan using a home equity.

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