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What is a home equity loan?

A home equity loan (HEL) is a type of mortgage that allows you to tap a portion of your home’s equity and receive the money in a lump-sum payment.

Home equity loans are typically issued as fixed-rate loans in terms of five to 15 years. Home equity loans are called “second mortgages” because they are in second position behind your original home loan.

Why you might want a home equity loan

Common reasons to take out a home equity loan are:

  • To make major home improvements
  • To consolidate high-interest debt, such as credit cards or personal loans
  • To pay for college
  • To fund a new business
  • To buy a rental property

How to get the best equity loan rates

These five strategies may help you snag the best home equity loan rates:
  1. Boost your credit score. Pay your credit card balances off monthly, if possible, and don’t be late. A FICO Score of 740 will usually get you the lowest home equity loan rate offers.
  2. Pick a shorter term.  Home equity lenders usually offer lower rates for shorter terms. A five-year, fixed-rate term will get you the lowest interest rate if you can swing the higher monthly payments.
  3. Watch your debt-to-income (DTI) ratio. A measure of your total monthly debt payments divided by your gross monthly income, a DTI ratio of 43% or less will get you the best HEL rates.
  4. Borrow less of your home’s value. The more equity you leave in your home, the lower your home equity loan rate may be.
  5. Shop around with at least three to five lenders. Some lenders are more competitive than others. Research has shown comparing home equity loan offers saves consumers thousands of dollars, and is one of the best ways to ensure you get the best home equity loan rates.

Home equity rates vs. mortgage rates: What’s the difference?

Home equity loan rates are typically higher than regular mortgage rates because they are considered second mortgages. That means if you default, the home equity lender is second in line to be repaid; your current mortgage would be repaid first. 

If home values drop in your neighborhood, you might not have enough equity to pay off both your first and second mortgage if you have to sell your home. Or, if you fall on hard times, you might have to prioritize making payments on your first mortgage, leaving you behind on your second. Lenders consider these extra risks when offering HEL rates.

Pros and cons of home equity loans

  • Fixed-rate payments for the life of the loan>
  • Lower interest rates than credit cards or personal loans
  • Tax-deductible interest if used for home repairs or improvements
  • No prepayment penalties or annual fees
  • Higher interest rates than home equity lines of credit (HELOCs) or a first mortgage
  • Closing costs as high as 2% to 5% of the loan amount
  • Less profit when you sell your home if you still have a HEL balance
  • Loss of your home if you default

Home equity closing costs

You’ll pay 2% to 5% of your loan amount toward HEL closing costs. Lenders may offer different closing cost options, including discounts on fees. Others may offer a higher rate option with lower costs. Below is a list of the most common home equity loan closing costs.

Type of Fee Amount Why It’s Charged
Appraisal fee $300 to $400 To pay for a home appraisal that analyzes your home’s value
Credit report fee $30 to $50 To verify your credit history and FICO Score
Document preparation and attorney fees Varies To prepare your paperwork and manage the loan closing
Loan origination fee Varies To pay for processing and approving your loan, and compensating your loan officer
Notary fee $50 to $200 To cover the cost of someone coming to your home or workplace to have your closing paperwork signed
Title search $75 to $100 To check for any title claims against your home
Title insurance Varies To insure your home against any outstanding ownership claims

Home Equity Loan Calculator

If you’re considering a home equity loan, a HEL calculator may give you an idea of how much you can borrow. You can typically access up to 85% of the value of your home, also known as your loan-to-value ratio (LTV). Some home equity lenders may approve you for a higher LTV ratio, but it’s best to leave some equity in place in case home values fall and you need to sell your home.

To use a home equity loan calculator, input these three pieces of information:

  1. An estimate of your home’s value. An online home value estimator can give you a ballpark idea of your home’s current market value. However, home equity lenders usually require a home appraisal to get a precise figure.
  2. Your outstanding mortgage balance. You can find this amount listed on your monthly mortgage statement, or call your current mortgage servicer.
  3. Your credit score. The credit score a lender uses depends on which credit bureau is selected (Equifax, TransUnion or Experian). You can check your score for free through My LendingTree.

 

Enter the above information into the home equity loan calculator for an estimate of the amount you might be able to borrow.

Alternatives to home equity loans

If you’re not sure whether a home equity loan is best for your situation, consider these three options instead:

  • Home equity line of credit (HELOC)

    A home equity line of credit, or HELOC, works similar to a credit card. It’s a revolving line of credit you can draw on when and as often as needed. HELOCs usually come with variable interest rates, though some lenders do offer fixed-rate HELOC options.

    You’ll typically have a 10-year draw period when you can tap the available credit line. You’ll pay interest only on the amount you take out. After the draw period ends, you’ll enter the repayment period where you’ll pay off the remaining balance. 

    How it compares to a home equity loan

    • – You don’t have to take all the funds in one lump sum.
    • – Your payment is based only on how much you draw, not your credit line.
    • – You can make interest-only payments during the draw period.
    • – Your rate is usually variable, which means your payment could go up or down.
    • – You may have to pay annual fees, prepayment penalties and maintenance fees.
    • – You could lose your home if you default, just like a HEL.

  • Cash-out refinance

    If current mortgage rates are low, it may be worth replacing your existing home loan with a new mortgage with a larger loan amount and pocketing the difference with a cash-out refinance. Choose from conventional or government-backed cash-out refi programs, of which the latter offers more flexibility for lower credit scores than home equity loans. 

    How it compares to a home equity loan:

    • – You’ll pay lower interest rates compared to a HEL or HELOC.
    • – You’ll pay higher closing costs, because you’re borrowing more money than you would with a HEL.
    • – You can borrow up to 80% of your home’s value with lower credit scores and higher DTI ratios than a HEL allows if you take out a conventional loan or a cash-out refi insured by the Federal Housing Administration (FHA).
    • -You can borrow up to 90% of your home’s value if you’re a military borrower eligible for a cash-out refinance backed by the U.S. Department of Veterans Affairs (VA).

  • Reverse mortgage

    Homeowners 62 years or older may be eligible for a reverse mortgage, which allows you to convert your equity into income or extra cash without having to make a monthly payment. The big difference between a reverse mortgage and a regular “forward” mortgage, like a home equity loan, is your loan balance grows and your home equity shrinks over time. 

    How it compares to a home equity loan:

    • – You have more options for how you receive your equity than a HEL in a lump sum, as a line of credit or as monthly payments
    • – You cannot deduct mortgage interest paid on a reverse mortgage on your taxes, but you can with a home equity loan if you use the money for home improvement
    • – Your debt load increases each month with a reverse mortgage versus dropping with each HEL payment
    • – You’ll likely spend more on closing costs for a reverse loan than a home equity loan, with one-time upfront origination fees as high as $6,000

Home equity loan FAQS

Home equity is the difference between your home’s market value and what you currently owe. As you pay your mortgage balance down and home values increase over time, home equity usually grows, too.

To calculate how much home equity you have, subtract the outstanding loan balance from the value of your home. For example, if your home is worth $200,000 and your mortgage balance is $150,000, you have $50,000 of equity.

Most home equity lenders let you tap up to 85% of your home’s equity. Some lenders may allow you to borrow more.

Home equity loan interest rates change with the financial markets, but are typically lower than other forms of borrowing, such as personal loans or credit cards.

It may take two to four weeks to close on a home equity loan. You may receive the funds at closing or a few weeks later, depending on the lender.

Making late payments on a home equity loan could damage your credit score. If you default on a home equity loan, you could lose your home because your home is the collateral that secures the loan.

Yes, but interest rates will be higher and there will be more LTV restrictions.

If home equity loan funds are used for home improvement, the loan interest can be deducted on your annual tax bill.