Home Equity Loans and Interest Rates

Home equity loans can help you consolidate high-interest debt and pay it off at a lower rate.

If much of your wealth is tied up in your house, a home equity loan can enable you to use some of that capital to take care of your immediate needs, without having to sell your home.

Those needs may include home improvements or medical bills. An increasingly popular strategy is to use a home equity loan to consolidate a number of high-interest-rate debts so they can be paid off at a lower rate. Whatever the purpose, a home equity loan has some unique advantages that allow you to get the money you need at the lowest cost.

Some of the interest rate advantages of a home equity loan are:

Low rates
Since a home equity loan is secured by your house, you can get a favorable interest rate -- usually below the rate for a regular personal loan, and well below credit card rates. The home equity rate is generally higher than that of a first mortgage, but if rates are falling, it can be lower.

Interest deductibility
Because the loan is secured by your home, you also get a second bonus. The interest on a home equity loan is usually tax-deductible, up to a maximum of $100,000, depending on how much equity you have in your house. Consult a

Flexibility
Home equity loans come in different forms that allow you to take advantage of interest rate changes. A fixed home equity loan, also called a term loan, has a set interest rate. That makes it a good choice if rates are rising since you can lock in the rate. It's also a good choice if you have a specific purpose for the loan, such as a home renovation, that requires a set amount of money.

If your need for cash will be ongoing or occasional, you can choose a home equity line of credit. This lets you borrow as much as you need when you need it (up to a set credit limit), typically using special checks tied to the loan. The money you borrow carries the current interest rate, so you can take advantage of falling rates. However, it also exposes you to higher payments if rates are rising. The line of credit has a cap, limiting how much the rate can increase, so you have some protection. And, of course, you can always slow your borrowing or repay what you've borrowed before rates get too high.

A home equity loan is a good way of getting needed funds at an affordable rate. But, as with all types of debt, it's wise to avoid borrowing more than you can repay. Remember that since the loan is secured by your house, the lender could foreclose on your home if you don't repay the money. If you're not comfortable with that risk, a conventional loan might be a better choice.

Since the interest rates on home equity loans generally follow the federal funds rate, it pays to check your newspaper's financial pages for moves in that key interest rate. That can help you decide which option to choose.