Lines of Credit Offer Some Flexibility

Question: I want to redo my kitchen and consolidate some credit card debt. Should I get a home equity loan or a line of credit?

Answer: Home equity loans and home equity lines of credit are both second mortgages, secured by a lien on your house. But they work a bit differently.

A home equity loan gives you a onetime amount, generally $10,000 or more. The loan carries a fixed rate of interest and requires a set monthly payment over its five-to 10-year life.

A line of credit works more like a credit card. It allows you to borrow money as you need it, up to a preset ceiling, over five to 10 years. The interest rate is variable and depends on the prevailing prime rate as well as how much you’ve got outstanding.

Doreen Woo Ho, president of Wells Fargo’s home equity division, says there are geographic preferences when it comes to second mortgages.

Families in the West, for example, tend to prefer lines of credit, while those in the Midwest go for loans.

“The advantage of a line of credit is the flexibility,” Woo Ho said. “You use it only when you need it, then pay it back.”

That means if you plan to remodel your kitchen in dribs and drabs--say a new stove now, a tile floor next spring, a new dining nook the following year--a line of credit might be preferable.

But if you need to make a big payment to a contractor now, with the balance due in the couple of months, a loan might be a better way to go.

“A loan also can be better for some because it imposes a disciplined monthly repayment schedule,” Woo Ho said.

Many people use second mortgages to consolidate their credit card debt.

The advantage is that the interest rate generally is significantly lower on a home equity loan or line of credit than on a credit card, and you can deduct the interest you’ve paid at tax time, said Greg McBride, a financial analyst at Bankrate.com.

But there also can be pitfalls, McBride warned.

“You have to watch it and not run out and run up more credit card debt, or you’ll end up repaying both your consolidation loan and more credit card bills,” he said.

Another thing to watch for is that some lines of credit have “teaser rates” like credit cards--low introductory rates that adjust higher after just a few months, McBride said.

And he emphasized that swapping credit card debt for a second mortgage carries an added risk.

“Your home could be on the line if there’s delinquency or default,” McBride said.

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Consumers seeking further information on second mortgages can find it in a government publication, “When Your Home Is on the Line: What You Should Know About Home Equity Lines of Credit.”

The brochure can be ordered for 50 cents from the Consumer Information Center, Department 371H, Pueblo, CO 81009.