What Is a Home Equity Loan? Your Guide to When It’s a Good Option
A home equity loan is a type of second mortgage that lets you to borrow cash using your home’s equity as collateral. It’s called a second mortgage because most people who get a home equity loan already have a first mortgage — the one they used to buy their home. The home equity loan is second in line to be repaid if you default on your mortgage and the lender forecloses on your home.
There are no limits on how you can use the money from a home equity loan. Since all the money is provided upfront, it is often used to pay for big projects like home renovations.
What is home equity?
Home equity is the portion of your home that you own outright, and builds as you make mortgage payments over time. You can calculate roughly how much home equity you have by subtracting how much you owe on your mortgage from your home’s value. The amount of home equity you have can fluctuate if home prices in your area either shoot up or drop significantly. If prices increase, you’ll find yourself with more home equity without having to lift a finger. But if they go down you can lose equity and, in a worst-case scenario, end up underwater on your mortgage.
You’ll build home equity much faster with a 15- versus 30-year loan because your monthly payments will chip away at the loan’s principal balance faster.
How a home equity loan works
Home equity loan funds are disbursed in one lump sum and you repay the money in equal monthly installments. Interest rates for home equity loans are fixed, which means your monthly payments won’t change due to market conditions like they would with a variable interest rate. Home equity loan terms can be as short as five years or as long as 30 years.
Because the loan is secured by your home equity, the maximum amount you can borrow is based on your home’s appraised value — you can typically borrow up to 85%. Your personal debt load, income and credit score will also help determine your loan amount and interest rate.
But remember: The stakes are higher with a home equity loan because it’s secured by your home. If you can’t make your payments, the lender could foreclose on your house.
What is the monthly payment on a $100,000 home equity loan?
How to get a home equity loan
The process for how to get a home equity loan is very similar to the way you get a mortgage:
- Apply with multiple lenders and compare offers. You should compare at least three to five lender loan estimates before choosing your lender to get the best interest rate and loan for you. See our picks for the best home equity lenders to get started today.
- Provide qualification documents. Your lender qualifies you based on your income, current mortgage information, and credit score.
- Get an appraisal. A home appraiser will verify your home’s value before the lender finalizes your home equity loan amount.
- Close on your loan. You’ll pay your home equity loan closing costs — which often range from 2% to 5% of your loan amount and can be taken from your loan or paid out of pocket— and sign some paperwork.
The home equity loan process generally takes about two to four weeks. You’ll receive your money after a mandatory three-business-day waiting period that begins once you’ve signed your closing documents.
How much equity can I borrow from my home?
Most home equity lenders only let you tap up to 85% of your home’s value. Some lenders may set different maximums, but they all represent their limit using a loan-to-value (LTV) ratio that compares your loan amount to your home’s appraised value.
Use our home equity loan calculator to quickly estimate how much money you could borrow.It’s possible to find lenders who offer high-LTV home equity loans, which give you the opportunity to borrow all or almost all of your home’s equity. In those cases you may want to calculate your maximum loan amount by hand.
Example home equity loan calculation
Let’s say you currently owe $250,000 on your home and your lender allows you to tap up to 95% of your home’s value. Your home was recently appraised at $350,000.
- Multiply your home’s value by 95% (0.95): $350,000 x 95% = $332,500
- Subtract your loan balance from the result: $332,500 – $250,000 = $82,500
- Your maximum home equity loan amount: $82,500
Keep in mind that most lenders will calculate your LTV by combining your first mortgage and the second mortgage you’re applying for. That’s why we subtracted your current mortgage balance in the second step.
Home equity loan requirements
Home equity loan requirements are a little more strict than mortgage or refinance guidelines. Here’s a quick overview:
Maximum 43% DTI ratio
Home equity lenders divide your total debt by your income before taxes — a calculation called your debt-to-income (DTI) ratio — and generally set the maximum at 43%.
Minimum 620 credit score
Lenders are more likely to charge you a higher interest rate for a home equity loan if you’re near that minimum 620 score, and some may require a minimum between 660 and 680.
Not sure what your credit score is? Get your free credit score and more on LendingTree Spring.
Maximum 85% LTV ratio
Some specialized home equity lenders set LTV ratios at 90% or higher, while most follow the 85% LTV maximum.
Home equity loan pros and cons
| Pros | Cons |
|---|---|
Stable monthly payments. The predictability of a home equity loan's payments can make budgeting easier. Tax benefits. The interest you pay may be tax-deductible if the loan proceeds are used to buy, build or improve a home. Lower costs and fees. Home equity loan closing costs are typically more affordable than what you'd pay with a cash-out refinance. Flexibility. Home equity loan funds can be used for any purpose. | Possibility of foreclosure. If you default on the loan, your lender could repossess your house. High bar to qualify. The financial profile needed to qualify is stricter than you'd find with a cash-out refinance, credit card or personal loan. Multiple payments. You'll have two monthly mortgage payments if you take out a second mortgage while still repaying a first mortgage. |
What can I use a home equity loan for?
You can use home equity loans for just about anything, including:
- Completing home renovations and energy-efficient upgrades
- Debt consolidation to clear out high-interest-rate credit card balances
- Buying a rental property
- Expanding or starting a business
- Avoiding mortgage insurance with a piggyback loan
How to apply for a home equity loan
When you are ready to apply for a home equity loan, you should follow the steps below:
The easiest way to figure out how much money you could qualify for with a home equity loan is to use an online home equity loan calculator. If you’d like to do the math by hand, simply multiply your home’s value by 85% (0.85), then subtract what you have left to pay on your current mortgage. The result is a rough estimate of your maximum home equity loan amount with an 85% LTV maximum.
How much debt and income do you have? How much room in your budget does that leave for a home equity loan payment? To help answer this question, you may want to calculate your DTI. If it’s over 43%, a home equity loan may not be an option for you. Ways to reduce your DTI include getting a cosigner, working on paying off old debts or increasing your income.
Reach out to three to five lenders and see what kind of home equity loan terms they may be willing to offer you. You can contact banks, credit unions, and online lenders to get quotes to compare and find your best offer. Make sure you look at quotes for interest rates, loan terms and monthly payments, costs and fees, and other details to make sure you choose the best deal for you.
After you choose your lender, you’re ready to submit a home equity loan application. You must provide the required information and documentation to the lender. Check with your lender to find out how you can submit your forms: through an online application, over the phone, or in person.
As your lender reviews and verifies your application, they will reach out if they have any additional questions they need you to answer. One question most lenders ask is to see an appraisal on your home to confirm its value, so you should plan to schedule time for an appraiser to visit your house. This part of the application process can take two to four weeks as all of your information is checked.
Once your application is approved, you will need to review and sign the required paperwork and pay any closing costs for your home equity loan. After a mandatory three-business-day waiting period, you’ll have access to the lump sum of cash from your loan to start using for whatever you need.
Where can I get the best home equity loans?
Banks and credit unions are a solid bet for getting a home equity loan, but there are also online home equity lenders to consider as well. Ultimately, you should research lenders and comparison shop to get the best deal on a home equity loan. If you’re not sure where to start, check out our list of the best home equity lenders in the table below.
Lender | LendingTree rating | Available features | |
|---|---|---|---|
User Ratings & Reviews
Ratings and reviews are from real consumers who have used the lending partner’s services. | 680 minimum credit score 90% LTV with higher score $45K minimum draw | Get Offers | |
 User reviews coming soon | 5- to 30-year terms No-closing-cost options 100% LTV for qualified borrowers | Get Offers | |
 User reviews coming soon | 5- to 30-year terms $10K to $500K loan amounts 0.25% rate discount for eligible borrowers | Get Offers | |
 User reviews coming soon | 5- to 30-year terms 0.50% rate discount for eligible borrowers No upfront fees | Get Offers | |
User Ratings & Reviews
Ratings and reviews are from real consumers who have used the lending partner’s services. | 5- to 30-year terms $500K maximum loan amount 14-day closings possible | Get Offers |
Read more about how we chose our best home equity loan lenders.What are current interest rates for home equity loans?
Learn more about getting the best home equity loan rates.
Home equity rates rise and fall with the financial markets just like mortgage rates. They are usually higher than alternatives like home equity line of credit (HELOC) rates or cash-out refinance rates. You can check current home equity loan rates online or by calling home equity lenders in your area.
Is a home equity loan a good idea?
A home equity loan can be a good idea for you if you’re using it to:
Make necessary home improvements, especially those that will increase your home’s value
Pay off or consolidate debt
Fund a business venture that’ll turn a profit.
When is a home equity loan a bad idea?
Home equity loan vs. home equity line of credit (HELOC)
Similar to a home equity loan, a HELOC is a second mortgage that allows you to convert some of your home equity into cash. The main difference is that a HELOC is a revolving line of credit, like a credit card, that comes with a variable interest rate.
During the HELOC draw period, you can use and reuse the credit line as many times as you need, as long as you don’t exceed the limit. Many times, you have the advantage of low, interest-only payments during this phase. But once the repayment period begins, you can’t withdraw from the credit line anymore and must repay the loan balance and interest in full.
When a HELOC may be a better choice for you:
A HELOC is a good choice for borrowers who know they want to make several purchases or cover ongoing expenses, or those who could benefit from interest-only payments during the draw period.
Still not sure which is right for you? Read our article comparing home equity loans versus HELOCs.Home equity loan vs. cash-out refinance
A cash-out refinance is when you take out a new mortgage to replace your current home loan. The new loan balance covers more than just your outstanding mortgage — it’s large enough to allow you to also pocket the remaining difference in cash.
When a cash-out refinance may be a better choice for you:
A cash-out refinance is a good option for those who can use a refinance to get better loan terms. However, if your existing mortgage rate is significantly lower than current refinance rates, you probably won’t want to replace it with a loan that will cost you more in the long run.
Not sure what to choose? Read our comparison of cash-out refinances vs home equity loans vs HELOCs.Home equity loan vs. personal loan
A personal loan is an unsecured loan that pays you a lump sum of cash. Unlike the other options we’ve mentioned, it doesn’t tie your new debt to your home. This can offer some peace of mind but, because there’s no collateral securing a personal loan, they generally come with higher interest rates.
When a personal loan may be a better choice for you:
A personal is a good choice for borrowers don’t own a house or have great credit and don’t want to tie their new loan to their home. If you’re moving or home prices are dropping in your area, a personal loan will make the most sense to make sure you can still get the money you need.
Learn more about whether a personal loan vs. a home equity loan is better for you.Frequently asked questions
Yes, bad credit home equity loans are available from some lenders. However, be prepared for a much higher rate and less borrowing power than you’d see with loans for high-credit-score borrowers.
The principal balance of a home equity loan is not tax deductible, but the interest you pay on it may be. According to IRS rules, if you used the funds to “buy, build or substantially improve” your home, you can deduct the interest. However, there are caps on how much interest you can deduct that vary depending on when you took out the loan and whether you’re a single or joint tax filer.
Using a home equity loan for home improvements is just like using any other funding source. Just make sure the interest rates and other loan terms suit your specific situation better than the other options available to you. Alternatives include HELOCs, personal loans, cash-out refinances and credit cards.
Home equity loan closing costs are usually about 2% to 5% of your loan amount. According to a recent LendingTree study, the average home equity loan borrowers paid between $1,600 to $4,000 in closing costs.
Most lenders require at least a 620 credit score to qualify for a home equity loan or HELOC.
There’s no waiting period for home equity loans — you can pull equity out of your house at any time, as long as you can meet the lender’s requirements. Most lenders require you to maintain at least 15% equity, so you may not qualify if you made a low down payment or haven’t been in the house long. But, with a little searching, you can find lenders who set the bar lower.