So should you look for a traditional home-equity loan (that pays you right away) or a home-equity line of credit (that extends a line of credit)?

Well, if you have a single, discrete expense (like a kitchen remodel), a regular home-equity loan is the right move. You get your money, you pay for your project and you start repaying the loan right away—in monthly payments that never change over the life of the loan.

But if you’re looking at a series of payments over a period of time, or want a safety net that you can bail you out at a moment’s notice, a HELOC is the better choice—you’ll only pay for the money you need.

Most home-equity loans and HELOCs use the following formula to determine how much to lend:

75-80% of current home’s value (determined by an appraiser’s visit, which you pay for, and costs a couple of hundred dollars) minus the amount you owe on your mortgage. In the current market, where real estate values have declined, getting a HELOC has become tougher, but it’s still an option for many homeowners.

Here’s an example that assumes the bank will lend 75% of your home’s value:

Current home value: $400,000
75% of current value: $300,000
Size of your mortgage: $250,000
Amount lent to you: $50,000

Some lenders will lend you even more than 80% of the value of your home – up to 100% or even 125% of the home’s value. But a home equity loan that large is risky, since your home might not appreciate that much by the time you’re ready to sell. Indeed, home values haven’t risen much at all of late. If the home value declines or doesn’t rise much, you could get stuck owing money on your home equity loan, even after you sell the house. Here’s how such a huge home equity loan can become a huge headache:

Current home value in 2008: $400,000
125% of home value: $500,000
Size of your mortgage: $250,000
Amount lent to you: $250,000
Sale price of your home in 2011: $475,000
Mortgage in 2011: $240,000
Total amount owed (mortgage and home loan): $490,000

In this example, the total amount you still owe the bank when you sell your home is $15,000 more than the price you get for your home. And that’s not even including the closing fees, moving expenses, and other costs that come with selling your house! You are probably reading about a lot of people getting into trouble because they took out more money than their houses were worth, and then couldn’t pay off the debt.

Again – approach these kinds of loans with care because you could end up owing more than the house is worth, especially if your home price declines or stays flat after you take out your HELOC.

Want to Know More?

• What's Home Equity?
• Advice on Where and How to Get a Good Deal
• Grilling Guide: Questions to Ask When Shopping for Home Equity