Home equity is the difference between what you owe on your mortgage and the fair market value of your home. Cashing out on home equity for debt consolidation is continuing to gain popularity. The typical way to cash out on home equity is to either refinance an existing first mortgage or take out a second mortgage.

Many people wonder why the interest rates for second mortgages are higher than those for first mortgages. The reason for this is a second mortgage is a subordinate loan secured by the same property as the first mortgage. Thus, if the mortgage isn’t paid and there is a foreclosure on the property, the first lender is paid off before the second lender. As a result, second mortgages entail more risk for the lender. To offset the risk, lenders charge higher interest rates for second mortgages than for first mortgages.

According to BankRate, second mortgage and home equity lines of credit have become increasingly common since the mid-1980s as property values have soared and homeowners have learned about managing personal debt. Among the reasons for this surge in popularity: attractive interest rates and tax deductibility. Many times, home owners can deduct up to 100% of the interest they pay on mortgage loans off their taxes.

If you need to draw equity from your home and the rates on your first home are lower than the current rates, it will probably be cheaper to get a second mortgage even though interest rates are higher. If you have a specific purpose for the loan that requires a specific amount of money, a home equity loan, also known as a home equity installment loan (HEIL), may be your best bet. Home equity lines of credit (HELOCs) are useful for those who have an occasional or on-going need for money because interest is only charged on the amount of equity used.

Compare the annual percentage rate (APR), the cost of credit on a yearly basis, when shopping for a second mortgage. Unlike home equity loans that include the total credit costs for the loan, the advertised APR for home equity credit lines is based on interest alone. For a true comparison of credit costs, compare other charges, such as points and closing costs, which will add to the cost of your loan.

Author: Maria Ny