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By BankingMyWay.com Staff
For many people, home equity is one of their most valuable assets. While falling home prices have caused an erosion of equity throughout the country, some Americans still have enough equity in their homes to borrow against.

Drawing on home equity is more difficult and costly than it has been in years past thanks to the credit crunch, but it is still possible.

There are two ways to borrow against your home equity; a home equity loan (HELs) and a home equity line of credit (HELOCs). Both of these options are second mortgages that use your home as collateral. Because they are secured, they typically offer lower interest rates than credit cards, and in most cases, both loans offer the added benefit of tax-deductible interest payments. As second mortgages, however, they carry higher interest rates than primary mortgages. Both loans typically require an appraisal of your home and these days, most lenders want borrowers to maintain at least 20% equity after the loan.

A home equity loan is similar to a mortgage in that funds are borrowed in one lump sum and paid back over a fixed term, like 5 years. Home equity loans usually carry a fixed interest rate, so monthly payments remain constant. (You can choose an adjustable rate HEL as well) -- the shorter the repayment term, the lower the interest rate.

To open a HEL, you usually need to pay closing costs, but these closing costs are typically lower than mortgage or refinance closing costs.

Conversely, home equity lines of credit typically require no closing costs. HELOCs operate similar to credit cards in that they are revolving accounts that allow borrowers to withdraw funds as needed, up to their approved limit. The money is accessed using either checks or a credit card. The interest rate for HELOCs float with the market, so the monthly payments can vary, and some charge an annual fee.

Like credit cards, HELOCs typically charge a minimum monthly payment. This payment often only needs to cover the interest charges.  For example, a line of credit with a $20,000 and an 8% interest rate might only have a $133.33 payment to cover the monthly interest. Paying only the minimum though fails to pay off any principal and the debt remains unchanged. Most HELOCs have a 10 to 20 year period in which the line of credit is open. When the line is closed, borrowers have to pay off the remaining balance within a fixed period.

However, the best use of a HELOC is as an emergency fund.  Having access to a large amount of credit at a low interest rate can help get you through tough economic situations such as the loss of a job or unexpected medical bills. Using a HELOC for emergency expenses will cost less than using a credit card.

The best use of a home equity loan is to finance a single large expense such as home improvements or start-up costs for a business. With a fixed interest rate, the payments will remain the same, allowing you to set up a more solid repayment plan.

— For more ways to save, spend, invest and borrow, visit MainStreet.com.