Borrowing on equity: Loans vs. credit lines

Q A friend of mine has a large amount of credit card debt. Where can she find information about whether it's better to get a home equity loan or a line of credit?

Last update: November 16, 2006 - 6:35 PM

Q A friend of mine has a large amount of credit card debt. Where can she find information about whether it's better to get a home equity loan or a line of credit?

ANDREA, MINNEAPOLIS

A Interest rates on home equity loans and home equity lines of credit are almost always lower than non-introductory credit card rates. Current interest rates, loan cost information and helpful calculators can be found on websites such as www.bankrate.com. You could also call banks in the area to see whether they offer any unpublished promotional rates.

However, when deciding between a home equity credit line and a home equity loan, there are other factors to consider besides interest rates and fees.

For one, you need to have available equity in your home to borrow against. Traditionally, lenders like to see a loan-to-value ratio of 80 percent or less. In other words, if your home is valued at $200,000, the first mortgage and any additional home-equity loans should total less than $160,000. However, many lenders today offer loans up to 100 percent of home value.

You should also understand the differences in a credit line vs. a home equity loan. A credit line is revolving, with a variable interest rate that fluctuates depending on market conditions. A credit line requires monthly interest-only payments.

A home equity loan, however, typically requires monthly principal and interest payments, does not allow for additional funds to be drawn after the loan is originated, and charges a fixed rate of interest. Often, home equity loans will have a slightly higher interest rate than a credit line because a borrower is charged a premium for locking in a fixed rate.

When using home equity to pay off high-interest credit cards, it often makes sense to opt for a home equity loan. This way you aren't tempted to treat your home as a cash machine and draw on a credit line to make everyday purchases. Also, the required monthly payments have a portion of loan principal built in, forcing you to gradually pay down the outstanding balance.

Equity in your home can be a great tool to effectively eliminate debt. However, you need to be diligent at paying down the loan principal and avoid building additional credit card debt. Also understand that the loan is secured by your home and that if you stop making payments, the bank has the right to the collateral you put up to secure the loan -- your home.

BRANDON JONES (25)

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