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.
Common reasons to take out a home equity loan are:
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.
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 |
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:
Enter the above information into the home equity loan calculator for an estimate of the amount you might be able to borrow.
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
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:
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:
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.