Financial Literacy 2007 - Home equity
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home equity
Home equity borrowing pros and cons

You're taking on risk: "People need to be clear with themselves about the risks," says Porter. "Be very aware that your home and all the payments you have made toward it are the collateral. With unsecured credit, the interest rates are higher because it is the lender who is assuming the bulk of the risk. Securing your loan with your house as collateral means that you are assuming the bulk of the risk." You could lose your home.

It may limit your options: Your home's value may slide, leaving you owing more than you can get for your house if you try to sell. This is especially a problem for high loan-to-value (LTV) loans, in which the borrower can draw on up to 100 percent (and sometimes more) of the home's equity.

Understand the terms: Home equity lines of credit, or HELOCs, and many subprime loans often come with stiff prepayment penalties, sometimes equivalent to six months' payment. Adjustable-rate mortgages, or ARMs, frequently start off with a low teaser rate that increases after a set amount of time. Crunch the numbers on the ceiling amount; make sure you can afford your payments when the interest rises.

Plan for the unexpected: "Unexpected crises -- getting sick, getting hurt, losing a job, having spouse leave you -- almost all of us will experience this type of loss at one time or another and consumers need to build a cushion into their budget," says Porter. She further says, "If you tap into equity in good times, then you won't have money to tap in an emergency."

Don't ignore your other options

Lower interest rates can be enticing, but consumers should consider all other options before converting unsecured debt to a secured loan. Try these strategies.

Call credit card companies. See if you can work out a payment plan and negotiate lower rates.

Consider credit counseling. Choose a nonprofit credit counselor to negotiate on your behalf.

Cut back somewhere else. Get a cheaper car. Have a yard sale. Put your wallet on a diet.

Has home equity funded your dreams or turned into a nightmare? Share your story.

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