Homeownership offers a number of advantages, from tax savings and various social benefits (such as better educational outcomes for children and increased civic participation) to lower crime rates and improved health. One of the most cited benefits is the opportunity to increase your wealth over time by building your home equity.
There are several ways to access your home equity to improve your financial situation, including selling your home or doing a cash-out refinance of your existing mortgage. Depending on your needs, a home equity loan might be another option.
New American Funding
Minimum credit score
640
620 with a 65% LTV
HELOC Loan Rates
Lower than the national average
Days to close
5 days
640
620 with a 65% LTV
Lower than the national average
5 days
What Is a Home Equity Loan?
Often referred to as a second mortgage, a home equity loan allows you to borrow money using the equity in your home as collateral.
Equity is your home’s current market value, less any outstanding mortgage balance or other liens on the property. For example, if your home is worth $500,000 and you owe $300,000 on your mortgage, you have $200,000 in equity.
One potential risk of taking out a home equity loan is that you are putting your home on the line. If you can no longer make payments, the lender could foreclose on your home. The reduction in your equity could also impact your ability to sell your home for a profit in the future.
Related: What Is A Home Equity Loan?
How Does a Home Equity Loan Work?
Home equity lenders will evaluate your application based on several factors, including your income and employment status, credit score, debt-to-income (DTI) ratio and how much equity you have in your home. Most home equity loans require a minimum 660 credit score and a DTI ratio no higher than 43%.
Home equity loans are lump-sum loans, which means that you receive the total amount you’re borrowing upfront. Your interest rate and other loan terms will depend on your overall creditworthiness and how much you borrow. In general, though, interest rates for home equity loans are often lower than that for other types of loans, like personal loans, because they’re secured by the home itself.
Be prepared to pay closing costs of anywhere between 2% and 5% of your loan amount, like you would with a traditional mortgage.
Related: How Much Equity Can I Borrow From My Home?
Home Equity Loans vs. HELOCs
Another way to borrow from your home equity is with a home equity line of credit (HELOC). Although home equity loans and HELOCs both use your home as collateral, there are important differences between the two.
While home equity loans give you a lump sum, HELOCs are more like credit cards. You get a revolving line of credit that you can borrow from as needed—up to your credit limit—during what’s called a draw period. The draw period generally lasts 10 years.
HELOCs allow you to make interest-only payments on the amount of credit you’ve used during the draw period, after which you transition to the repayment period. Most HELOCs have a repayment period of 20 years. They generally have variable interest rates, too, meaning your payments could vary over time depending on broader market conditions.
In contrast, home equity loans have fixed interest rates and monthly payments, with terms ranging anywhere between five and 30 years. So, unlike a HELOC, your monthly payment will remain consistent for the life of the loan.
What Can I Use a Home Equity Loan For?
You can use a home equity loan for a variety of purposes, including:
- Home improvements. Using a home equity loan is a common way to fund home renovations or improvements, whether you’re eyeing a kitchen remodel or you need a new roof. What’s more, the interest you pay can be tax deductible when you use the funds to “buy, build or substantially improve” the home that secures the loan, per IRS guidelines.
- Debt consolidation. If you have high-interest debt, such as credit card debt or personal loans, a home equity loan can be a good option for consolidating what you owe into one monthly payment with a lower interest rate.
- Education. You can use the proceeds from a home equity loan to pay for the costs of higher education, including tuition, textbooks and room and board.
- Medical expenses. A 2022 Kaiser Family Foundation report found that 1 in 10 U.S. adults owe medical debt, including 3 million who owe more than $10,000. Home equity loans can help you manage both existing medical debt and ongoing medical expenses.
- Major purchases. From a new car to a dream wedding, a home equity loan can be a more affordable way to cover significant purchases, thanks to lower interest rates than other types of credit.
How Much Can You Borrow With a Home Equity Loan?
Before you apply for a home equity loan, you should have some idea of the amount you need. You’ll also need to have your home appraised to determine its market value, which—along with your financial profile and any existing liens on the property—is the biggest factor in how much you can borrow.
Most lenders will only let you borrow up to 80% of the total equity in your home. Using the earlier example, if your home has a market value of $500,000, but you owe $300,000 on your mortgage, you have $200,000 in total home equity. The most you could borrow with a home equity loan—assuming the lender’s home equity loan limit is 80%—would be $160,000.
In general, you should have at least 20% equity built up in your home to qualify for a home equity loan.
Related: How Much Equity Can I Borrow From My Home?
Find The Best Home Equity Loan Lenders Of 2024
Should You Get a Home Equity Loan?
Home equity loans are best for people who know how much they want to borrow, while those who aren’t sure how much money they need—as in the case of home improvements, the costs of which can go up or down—might want to consider a HELOC for ongoing financing.
Whether you choose a home equity loan or a HELOC for your financing needs, consider the pros and cons of each option and compare loan offers from multiple lenders.
