By: Yara Zakharia, Esq.

To gain access to a big chunk of money for financing everyday expenses or major projects, more and more Americans are tapping into their home’s equity. Equity is the value of the property owned by a homeowner apart from any amount owed on the home in terms of mortgages, liens or other forms of debt. Equity in real estate is calculated by deducting any unpaid debts on the property (such as the outstanding mortgage loan, liens, etc.) from the current market value of the property. Consequently, the equity in a property increases as the homeowner pays off the mortgage balance and other debts on the home. Another cause for the growth of equity in a home is due to an increase in the property’s market value. A homeowner acquires 100 percent of the equity in their property after all mortgage payments, liens and debt payments have been fulfilled.

For decades, homeowners across the United States have reaped the benefits of borrowing money against home equity, whether by way of the home equity loan or the home equity line of credit. From a financial standpoint, there is no better time to capitalize on either one of these instruments of home equity. Regardless of the borrower's objective, home equity loans or lines of credit are deemed to be "smart" methods of borrowing.

The decision of whether a home equity loan (HEL) or a home equity line of credit (HELOC) is more suitable for a particular borrower will depend on a host of variables. Therefore, it is essential that the consumer first understand how the two financing tools differ from one another.

The following discussion will outline the pros and cons of home equity loans and home equity lines of credit and will enable prospective borrowers to determine which use of home equity is right for them.

1. Home equity loan:

This type of loan (also called a "second mortgage") is for a specific amount with a fixed home equity loan rate and fixed monthly payments. A borrower's annual percentage rate (APR) and interest rate remain the same for the duration of the loan. Borrowers receive a lump-sum of money, which they pay back in set monthly installments over a fixed period of time. The home equity loan may be the preferred route for those who know exactly how much financing they need and have a specific project or purchase in mind. The installment payments will vary depending on the amount borrowed against home equity and the loan's term.

With a home equity loan, borrowers can:

• Borrow as little as $5,000 or as much as 100% against their home’s equity
• Convert some of their bad credit into good credit
• Consolidate their debt
• Have flexible payment options, since 5, 10, 15, 20 and 30-year fully amortizing loan terms are available
• Make a significant purchase
• Benefit from a low fixed home equity loan rate (which is lower than other forms of credit, such as unsecured personal loans and credit cards)
• Benefit from interest-only payments
• Deduct the interest paid on their home equity loan, up to $100,000 (other personal and consumer loans typically offer no such tax deduction)

2. Home equity line of credit (HELOC)

In this form of borrowing against home equity, borrowers make withdrawals from an account as needed, provided they do not surpass the credit limit assigned to them. A HELOC's mortgage rate depends on the prime rate, or the rate at which banks lend to their most creditworthy clients. Upon utilizing the home equity line of credit, borrowers will have to pay a monthly minimum on their outstanding balance. Beyond that, they decide how much to pay back and when. HELOCs function like credit cards and are appropriate for ongoing expenses.

When borrowing against home equity using this method, borrowers have the following advantages:

• The convenience of multiple withdrawals
• Interest-only payments for the first 10 years
• Credit lines up to $250,000
• No annual fee
• Withdrawal by check and from an ATM
• Reduction of their income tax burden
• Immediate credit
• An open end line of credit

It is advisable for consumers to borrow against home equity via lines of credit when they have one of the following goals in mind:

• The growth of their business
• The financing of an education (college tuition and expenses)
• Home improvements (renovating their home, building a pool)
• Consolidation of higher-interest loans and credit card debt
• Protection against employment uncertainty or catastrophic events
• The financing of a major purchase like a boat, furniture, a car, a new or second home or another high cost item

Homeowners should beware of borrowing against home equity more than they are able to pay and should refrain from using home equity lines of credit to pay for frivolous expenses. These two home equity products- the home equity loan and the home equity line of credit- are efficacious, powerful tools that enable borrowers to manage their home, most likely their biggest investment. Each borrower must determine the best solution for him and ensure that when borrowing against his home equity, the money is utilized wisely.