What is a home equity loan?
By Gideon Sandford
Published on January 30, 2023
Read time: 7 min
Home equity loans let you borrow cash against the value of your home
Interest rates for home equity loans are usually much lower than for credit cards
You can get a home equity loan even if you’re still paying a mortgage
If you own your home, it’s an asset that might help you reach other financial goals faster. That’s because you can borrow against your equity (your home’s value minus the amount you still owe on your mortgage).
There are plusses and minuses to borrowing against your home. On the upside, borrowing against your home can be less costly than using other kinds of financing (like credit cards). On the downside, you could lose your home if you can’t repay the loan.
Home equity loans make great sense in some situations. Here’s a breakdown of how they work and when they might be a good idea.
Home equity loan definition
A home equity loan — sometimes called a second mortgage — is a way to get cash from your home’s value without selling it. Because home equity loans use your home as collateral, they can have much lower interest rates than debt that isn’t tied to an asset (like credit cards).
Key terms to know if you take a home equity loan
When you take out a home equity loan you are using the equity in your home as collateral. That means the lender loans you the money and you agree that if you can’t repay the loan, they can step in and sell your home to recover the money they are owed. You usually can’t borrow more than a percentage of the value of your home, minus the amount of any loans you’ve already taken out against it (like your primary mortgage).
Home equity loans are sometimes called second mortgages because they’re secured by your home.
Fixed interest rate
Home equity loans usually have a fixed interest rate set when you take out the loan. A home equity line of credit (HELOC), on the other hand, is usually a variable-rate loan. It’s easy to mix up the two.
Loan to value (LTV) and combined LTV
The loan-to-value ratio is the percentage of your home’s value that you borrow. This percentage changes as the amount you owe goes down (or up) over time, and as the value of your home changes. For example, an $80,000 mortgage on a $100,000 house has an 80% loan-to-value ratio. If the value of the house goes up to $200,000, the same loan now has a 40% LTV.
Combined loan-to-value is the same ratio, but calculated using all the loans secured by your home. If you now take a home equity loan for $80,000 against the same $200,000 house, each separate loan would have a 40% loan-to-value ratio, but your combined loan-to-value ratio would be 80%.
Reasons to take a home equity loan
A home equity loan can give you the money you need for a large expense.
One of the top reasons people take out home equity loans is to pay for major home improvements. Think big-ticket items here, like renovating your kitchen, adding a deck, or replacing your roof. A home equity loan can turn a wish into a plan.
Not only can a home equity loan help you improve your standard of living, doing it this way is logical. It makes sense to borrow against your home for something that will add value to that same home.
Home equity loans can be used to consolidate other debts at similar or higher interest rates. Even when the rate on the home equity loan isn’t significantly better than the rate on your existing debts, a single monthly payment can help you simplify your financial life.
Paying off credit cards is one common use of a home equity loan. Credit cards might not be the most expensive kind of debt, but they’re way up there. If you have high-interest debt, you might be able to save money by paying it off with a home equity loan. Since home equity loans are secured by the home, they usually have much lower interest rates than credit cards.
Granted, there are some caveats here. For instance, if you move high-interest debt to a low-interest home equity loan but take 25 years to pay it off, you might not save money. But to be honest, you might not lose much, either. Plus, a home equity loan can give your monthly budget some much-needed breathing room while you create the payoff plan that works for you.
You can pay for a large purchase over time with a home equity loan, whether that expense is planned or unexpected.
Some of the planned expenses a home equity loan can help you cover:
A new set of appliances
Electronics or a home security system
Recreational vehicle or boat
Hard-to-finance car or collectible
A home equity loan can also be helpful for those big expenses that come up with little or no notice.
Even if you have health insurance, a sudden or serious medical issue can leave you on the hook for thousands or even tens of thousands of dollars. If you can’t pay right away, the bill might be sent to collections. Besides hurting your credit, collections can get worse over time as fees pile up. A home equity loan can help you avoid a landslide of negative consequences. Also, depending on your credit standing, you might find that the home equity loan has a lower interest rate than the medical loan programs you’re considering.
Is someone in your life hearing wedding bells? (We see you nodding, moms and dads.) Whether it’s your wedding or someone else’s, the betrothed deserve a day to remember. Unfortunately, you might only have a few months to prepare. Weddings can cost a small fortune, and many vendors impose a significant surcharge for using credit cards. A home equity loan can help you make the special day happen, potentially at a much lower cost compared to other options.
Maybe financial aid falls short, expenses rise, or your child opts for a private or out-of-state school. Maybe you decide to get that degree. A home equity loan can help bridge the gap between college savings and actual costs.
How hard is it to get a home equity loan?
Typically, borrowers with good to excellent credit and sufficient equity find that it’s not difficult to qualify for a home equity loan. Besides those two factors, the lender will also need to make sure that you can afford the payment with your current income. If you’re considering a home equity loan, the best strategy is to talk to a lender about your situation.
Frequently asked questions - What is a home equity loan
How does a home equity loan work?
Home equity loans work a lot like the mortgage you’d use to buy a house. You apply in pretty much the same way. The lender will look at your credit history and verify your financial information. They will probably order a property appraisal to find out how much the home is worth. The loan limit is set by the lender, but you can expect them to cap it so that your total mortgage debt (including your first mortgage) is no more than 80-90% of your home’s value.
Can I get a Home Equity Line of Credit (HELOC) with a fixed rate?
Yes, it's possible to obtain a HELOC with a fixed interest rate. While most HELOCs have a variable interest rate, some lenders offer fixed-rate options. Choosing a fixed-rate HELOC can provide stability and predictability since you won't have to worry about fluctuations in interest rates, making it easier to plan and manage your finances.
Is a Home Equity Line of Credit (HELOC) a good idea right now?
If you're a homeowner needing funds, a Home Equity Line of Credit (HELOC) with a fixed interest rate can be a great option. With a fixed rate, your interest rate will stay the same throughout the loan's life, making it easier to budget your monthly payments. Also, a HELOC can be a flexible and convenient way to access cash for home improvements, debt consolidation, or other expenses without affecting your first mortgage rate or terms.
What are home equity loan requirements?
To take out a home equity loan you need to have equity in your home. If your home has increased in value since you bought it, you may have more equity than you think, even if you’re still paying your first mortgage.
Lenders also need to make sure you’ll be able to repay the loan, so they’ll check your income and the amount you’re paying on any other debt. They’ll also check your credit score. You might be approved for a home equity loan with a credit score as low as 600, and a higher credit score can help you get a lower interest rate.
What's the difference between a home equity loan and a HELOC?
Usually, a home equity loan is for one lump sum and is repaid in equal installments over a predetermined amount of time.
A home equity line of credit, or HELOC, is paid out as you need it. You can pull money out during the draw period either by writing a check or using a linked credit card. During this time, you might only have to make interest payments. Once the draw period ends, you may not take any more money out, and you’ll start making a regular monthly payment that includes the principal plus interest.
Home equity loans usually have a fixed interest rate, while HELOCs typically have a variable rate that may change over time.
The Achieve home equity loan is unique because it combines the best features of home equity loans and HELOCs. Our loan comes with a draw period and a fixed interest rate. During the first five years, you can borrow, repay, and borrow more, up to your limit. Your rate will be set when you get your loan, and it won’t change for the life of the loan.