Five Tips for Borrowing From Home Equity

Home prices have fallen and lending restrictions have tightened up, but there are still times when dipping into your home equity is the right move.

Before you treat your home like a glorified ATM by borrowing against its value, consider these five tips.

Have a Good Reason

Make sure you're spending your home equity appropriately. "Proceeds from a home equity loan shouldn't be used to purchase something that you'll consume, like a vacation," explains Dylan Ross, CFP and founder of Swan Financial Planning in New Jersey. "It's better to use it to pay for an asset, like an addition on your home." That way you have a chance of recapturing some of that value instead of just spending it away.

Have a Plan

A home equity loan uses your home as security. That means if you default on the loan, you could lose your house. Consider laying out how you plan to pay back the loan, including what you'll do in the event that you experience a financial setback, such as a pay cut.

Check Your Credit

It's always good to monitor your credit reports, but consider checking your actual credit score before applying for a loan. Knowing your credit score in advance will give you a better idea of where you stand and can help you negotiate a better rate. (To get a free credit report, check out AnnualCreditReport.com; and to see your FICO score visit myFICO.com.)

Shop Around

Rates vary widely between lenders, so it's a good idea to look for the best deals. A search on BankingMyWay.com for rates in California, for instance, reveals US Bank (USB) offers a 60-month loan for 6.24%, while Central Valley Community Bank (CVCY) charges 6.75% on its 60-month loan. Other offers include an 84-month loan from Citibank (C) at 7.4% and a 120-month loan from Sierra Bancorp (BSRR) for 7.577%.

Weigh All of Your Options

Getting the lowest rate possible is important, but it shouldn't be your only consideration. You may qualify for an unsecured loan at an interest rate just slightly higher than the one on your home equity loan. An extra 0.5 percentage points on your annual interest rate might be a good deal if it helps you avoid the added risk to your home that an equity loan represents.

This article was written by a staff member of TheStreet.com.