This article is part of our Subprime Survival Guide.
With home prices apparently headed south and interest rates as high as they've been in years, you'd think few Fools would seriously be considering tapping into their home's equity. Not so.
If anything, we're using more equity than ever. Witness yesterday's earnings report from JPMorgan Chase (NYSE: JPM ) . The banker cited higher home equity loans in reporting a 2% increase in net interest income. Meanwhile, CNW Marketing says that 800,000 vehicle loans, or roughly 5% of all car sales, were financed through home equity.
We can debate the madness of financing a tricked-out '74 Pinto with equity later. For now, let's review your options if you're thinking of using your house like a credit card, beginning with the most common choice for consumers: the home equity line of credit, or HELOC.
Like plastic, but worse
Put simply, a HELOC is a credit card that's secured by your house. Fail to pay back the loan and the bank will foreclose.
So why get one? A HELOC typically charges no more than the prime rate in interest and, usually, all the interest you pay is tax-deductible. No credit card can offer you that.
What's more, banks make it easy to qualify for a HELOC and charge few or no closing costs, unlike a traditional mortgage. But that's where the benefits end.
Like a credit card, a HELOC is subject to the whims of the credit market, which means your interest rate can vary widely. That's how it has been for us. When I first became self-employed at the end of 2002, HELOC rates hovered near 4%. Today, we pay 8.25% on what we owe. Ouch.
That's why banks like selling the HELOC. As interest rates rise, they make more money. Keep a balance for years, as we have, and you'll make your bank manager smile. Don't let that happen. Instead, think of a HELOC as an emergency fund where borrowings are to be repaid as fast as is reasonable.
Just another mortgage
But what if you need more than the comfort of an emergency fund? What if you're looking to add on to your house or fund tuition for a child headed to college? These can be huge expenses that can take years to pay off.
Rising rates would make the job harder still. Banks know this, which is why they also offer home equity loans. Unlike a HELOC, a home equity loan operates almost exactly like a mortgage. You borrow from your equity at a fixed rate for a determined number of years.
And, as with a mortgage, you're likely to pay closing costs with a home equity loan. Why? Because banks can't depend on rising rates to earn the extra moola they might if they sold you a HELOC. Fees help them to close the gap.
Finally, loans are restrictive. I can walk into my bank today and get a check in 15 minutes under the terms of my HELOC, which makes it a wonderful choice as an emergency fund. Not so with home equity loans, which can take weeks to approve.
Follow the money
Which choice is best for you? Frankly, the answer may be neither. Home equity carries the risk of losing your house if you default. Why chance it if you have good credit?
Besides, there are other choices. Card issuers like American Express (NYSE: AXP ) and Citigroup (NYSE: C ) are increasingly offering zero- or low-interest fixed loans on new cards. We have a fixed 2.99% loan through Citi, for example. CardRatings.com is an excellent place to find more offers like this one.
Then there are fixed-rate lines of credit that blend the flexibility of a HELOC -- that is, you pull out money when you need it -- with a predictable payment schedule. The catch here is that, usually, only the first withdrawal is frozen at a fixed rate. Subsequent withdrawals may be subject to a variable rate.
Finally, before you consider borrowing a dime from anyone, check with your local credit union. Many are equipped to offer home equity financing and, because of their non-profit status, are more likely to offer great deals for members. Check with the National Credit Union Administration, or NCUA, to find accredited locations near you.
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Fool contributor Tim Beyers writes weekly about personal finance and investing. Have a Foolish money tip? Tell him. JPMorgan Chase is an Income Investor recommendation. The Motley Fool's disclosure policy is only interested in earning interest.