If you've owned a house for some time, you probably remember when home equity loans were a popular way to get extra cash. They were done all the time until around 2008 (see: The [not-so] Great Recession).
But time has passed, and you may have noticed your bank's advertisements suggesting you take out a home equity loan for home improvements or other expenses. In fact, earlier this year, CoreLogic Inc., a mortgage-data firm, released a white paper stating that, "after years of being out of favor, home equity lending is making a comeback." The paper noted that during the first three quarters of 2015, lenders originated almost 976,000 new home equity lines of credit, the highest numbers since 2008.
So are the ads and the wisdom of crowds right? Maybe – but before you invite a home equity loan to move in with you, learn about them first.
Your home equity terminology. A lot of people confuse home equity loans with home equity lines of credit, says Philip Lee, a certified financial planner with Financially in Tune, LLC in Wakefield, Massachusetts.
The main difference, Lee says, is that a home equity loan, or HEL, has a fixed rate. A home equity line of credit is variable.
But there are other disparities. Lee says that a HEL borrower receives a specific, predetermined loan while a HELOC borrower applies for a revolving credit line.
"For example, with a HEL you might borrow $50,000 for a bathroom renovation, a specific project," Lee says. "The HELOC borrower has the capacity to borrow up to $50,000 but may elect to tap only $35,000 while leaving $15,000 available."
Essentially, if you have home equity, you can apply for a loan – or get approval to use the money like a credit card and use it or not.
If you don't use it, eventually the bank may close down the offer or lower the amount, says Matthew Carbray, a certified financial planner in Avon, Connecticut. So that's something to be aware of.
But there are some other important nuances between a home equity loan and line of credit, notably in how you pay these loans back, Lee says.
For instance, that $50,000 for the bathroom renovation will probably be paid off in five or 10 years. If you borrow from a $50,000 line of credit, your loan will typically be 20 years or longer. For the first 10 years, you'll make low interest-only payments. After 10 years, you'll pay on the interest and principal, and your payments could shoot up.
The arguments for a HEL or HELOC. There is a long history of homeowners taking out home equity loans and lines of credit, says David Carey, a vice president and residential lending manager at Tompkins Mahopac Bank in Lagrangeville, New York.
The problem wasn't with the method of financing but of inflated home values and unscrupulous lenders who were too lax with their underwriting guidelines, Carey says.
But times have changed. "Regulations like Dodd-Frank and the formation of the Consumer Financial Protection Bureau have put protections in place to help prevent events like these from ever happening again," Carey says. (For more information on the Dodd-Frank Wall Street Reform and Consumer Protection Act, see "A Homebuyer's Guide to Federal Policy on Mortgage Lending.")
Still, even if you successfully pay back a home equity loan, that doesn't mean you won't regret the experience. Conventional wisdom says the smartest reasons to use your home equity include:
Home improvements. Nathan Miloszewski, a copywriter in Buffalo, New York, says he has been using a home equity line of credit for a few years to make necessary improvements on a duplex, with one unit that he rents out.
"For me, the timing couldn't be better. Rent prices continue to go up and home values are increasing in my city ... I would have had to make repairs regardless ... But now, it's turning into a good investment that I can leverage for another property in the future."
Education. Carey cites education as a perfectly reasonable reason to take out a home equity loan, as do many lending experts. College education is, after all, an investment in yourself or your kids.
For emergencies. Carbray recommends that most of his clients have a HELOC available to them.
"We encourage having a HELOC for emergency-reserves purposes and to provide an additional source of capital when withdrawals from a portfolio may be needed in times of a recession or market correction," Carbray says.
The arguments against a HEL or HELOC. If you struggle with money, down the line you may rue the day you took out the loan.
"You want predictable payments, and a schedule of repayment and have the cash flow to support it. Don't get a HEL just because the credit union or bank is urging you to borrow money," Lee says.
"Obviously, someone with discipline could take out an equity line and manage it properly," says Casey Fleming, a mortgage advisor in San Francisco and the author of "The Loan Guide: How to Get the Best Possible Mortgage."
"But most don't," he adds. "I have had many clients get stuck on the debt merry-go-round and never get off."
Despite what you may have heard, Fleming doesn't recommend using home equity to pay off the following:
A car. Especially when dealing with a line of credit versus a loan. Fleming stresses the fact that for the first 10 years of the equity line of credit, your payments only pay off the interest.
"Lenders sell this feature hard," he says. "So you buy a new car, which you'll have for maybe 10 years, and 10 years later, you still owe the full balance. Then you begin paying it off over the next 15. So you've financed an asset you'll use for 10 years over 25 years and paid probably three times its original cost."
Credit card debt. Another nope. "Now instead of financing your car for 25 years, you're financing your shoes for 25 years," Fleming says.
But if you have credit cards with a really high interest rate, and the interest on your home equity loan is super low – doesn't matter, Fleming says.
His reasoning: If you weren't disciplined enough to manage those credit cards, what makes you think you'll have better luck with a line of credit?
Williams got his start working in entertainment reporting in 1993, as an associate editor at "BOP," a teen entertainment magazine, and freelancing for publications, including Entertainment Weekly. He later moved to Ohio and worked for several years as a part-time features reporter at The Cincinnati Post and continued freelancing. His articles have been featured in outlets such as Life magazine, Ladies’ Home Journal, Cincinnati Magazine and Ohio Magazine.
For the past 15 years, Williams has specialized in personal finance and small business issues. His articles on personal finance and business have appeared in CNNMoney.com, The Washington Post, Entrepreneur Magazine, Forbes.com and American Express OPEN Forum. Williams is also the author of several books, including "Washed Away: How the Great Flood of 1913, America's Most Widespread Natural Disaster, Terrorized a Nation and Changed It Forever" and "C.C. Pyle's Amazing Foot Race: The True Story of the 1928 Coast-to-Coast Run Across America"
Born in Columbus, Ohio, Williams lives in Loveland, Ohio, with his two teenage daughters and is a graduate of Indiana University. To learn more about Geoff Williams, you can connect with him on LinkedIn or follow his Twitter page.