What is a home equity loan? How does a home equity loan work?

Much like your mortgage is a loan based on the appraised value of your home, a home equity loan is based on the amount of equity you've gained in the property. Home equity is essentially the gap between your home's present value and the amount you still owe.   

From the time you submit a down payment and begin making monthly payments on your mortgage, you are establishing equity in your house. This equity can be tapped into in the form of a home equity loan or as part of a refinance. As with any home loan, you’ll want  to make sure you’re getting the best deal. 

Are you ready to explore uses for the value of your home? Apply Now and see how you can secure your financial goals. 

What is a home equity loan? 

A home equity loan allows you to use your home as collateral to access cash in the form of a lump-sum payment. In effect, you are borrowing against your built-up equity at a fixed rate determined by current interest rates. 

How does a home equity loan work? 

Determining the maximum amount available for you to borrow requires a formula. 

First equation: Current home value x percentage of home value you’re allowed to borrow = maximum amount of borrowable equity 

Second equation: Maximum amount of borrowable equity − remaining mortgage balance = maximum amount you can borrow from your home equity 

Percentage of home value you’re allowed to borrow 

The percentage of home equity most lenders will allow you to borrow is usually 80% to 85% of your home equity. 

Because most home equity loans are second mortgages, the lender’s risk increases. If approved, you’ll have two loans to pay off: your initial mortgage and the home equity loan. To offset that risk while still offering you a cash loan, lenders impose some limits on the size of the loan while setting mortgage rates at a level above what they would charge for a first mortgage. 

Home equity loan requirements 

Each lender has different qualifications for home equity loans, but if you meet the requirements, you'll generally be a good candidate for approval. 

• Current home equity from 15% to 20% or more 
• A credit score of 620 or greater
• Debt-to-income ratio below 43% 
• Appraisal to determine fair market value of your home 

A is not necessarily a disqualifier for securing a loan, but it’s safer to be in the “good” or even “fair”  when applying for a home equity loan. 

Pros and cons of home equity loans 

A home equity loan can be a great way to access funds. But like any loan, it has pros and cons. 

Pros 

• Provides borrowers with a loan at a fixed interest rate.
• The loan is dispersed as a lump-sum, which could be a great benefit for consolidating debt or making a large purchase.
• Consistent payments every month for a predetermined amount of time.
• Money is tax deductible if . 

Cons 

• The loan could strain finances.
• Your home used as collateral sets you up for foreclosure should you be unable to make payments on the loan.
• Expect to pay from 2% to 5% of the loan amount in closing costs.
• You reduce existing equity by accessing cash funds.

Home equity loan vs. cash out refinance 

A cash-out refinance is another popular method for leveraging home equity to make cash available.* 

The key difference is that a cash-out refinance is  that replaces your original loan with one that has new interest rates and potentially new terms.  

A home equity loan is an entirely new loan that you must pay off in addition to your existing home mortgage. 

Both home equity loans and cash-out refinances rely on your home as collateral to obtain a loan. Both also r. 

Home equity loan vs. HELOC 

A home equity line of credit (HELOC) is a revolving credit line extended to borrowers up to a preset limit. Payments are not typically fixed, and borrowers could be subject to variable interest rates, much like credit cards.** 

A home equity loan, however, provides the homeowner with a lump sum, which they in turn must repay at a fixed rate over an agreed amount of time. 

With a HELOC, borrowers tap into their line of credit as needed, begin repayment and then return to the line of credit when they need additional funds.  

HELOC borrowers need to be careful to budget for  that can affect repayment amounts. 

How to apply for a home equity loan  

To apply for a home equity loan, you’ll need to provide income verification, tax returns, asset statements and personal identification. You’ll also want to be aware of your credit score.  

Your lender can provide you with guidance on scheduling a home appraisal if one is needed. 

Are you ready to get started on a home equity loan? 

_{* Using funds from a Cash-out Refinance to consolidate debt may result in the debt taking longer to pay off as it will be combined with borrower’s mortgage principle amount and will be paid off over the full loan term. Contact Rate, Inc. for more information.} 

_{** Rate, Inc.’s HELOC is a fixed-rate open-end product using your home as collateral. Not available in all states. Go to rate.com/HELOC for information including important property and borrower requirements and restrictions which impact rate and max available loan amount. Subject to approval.}