What is a home equity loan (HEL)?

A home equity loan is a type of loan that allows people to borrow money based on the equity in their homes. The funds it provides are often used for things like home repairs and renovations. 

Here’s a closer look at how home equity loans work, plus some pros and cons to consider.

Key takeaways

  • Home equity loans, sometimes called HELs, belong to a group of loans commonly referred to as second mortgages.
  • Home equity loans typically have a fixed interest rate and are paid to homeowners in a lump sum.
  • Repayment terms for home equity loans usually range from 5 to 30 years. 
  • Other types of loans based on the equity in a home include home equity lines of credit (HELOCs) and cash-out refinancing.
  • Failure to make payments on a home equity loan could result in foreclosure.

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What is home equity?  

Home equity is the difference between the market value of a home and any mortgages or loan balances owed on it. For example, if a house is appraised at $200,000 and the balance on its mortgage is $150,000, the owner will generally have about $50,000 in equity. 

As homeowners pay down their mortgage over time, they will generally build equity.

How does a home equity loan work?

Home equity loans typically involve an appraisal, which can help lenders establish a home’s value. They use that information to decide whether to offer the loan—and if they do, how much equity the borrower can access. 

Home equity loans are usually secured loans with a fixed interest rate. They’re paid out in a lump sum and then repaid over time. Because they’re separate from a home’s original mortgage, they belong to a group of loans commonly referred to as second mortgages.

Home equity loans generally come with a number of fees. They can also come with a penalty for paying off the loan early. Plus, if a homeowner can’t repay their home equity loan, they could lose their home. 

Repaying a home equity loan

Home equity loans are a type of installment loan. This means the payments—made up of the principal amount borrowed plus interest—are made over a fixed period of time. The loan amortization specifics can be similar to those of mortgages, including the fact that terms for both types of loans typically range from 5 to 30 years.

Requirements for a home equity loan

Qualification requirements for a home equity loan vary, but typically include the following: 

  • At least 15%-20% equity: Borrowers in this equity range can generally borrow up to 85% of the equity in their home. For example, if someone has $50,000 in home equity, they could potentially borrow up to $42,500.
  • A good credit score: In addition to a sufficient income, a good credit score generally helps. That’s because lenders may look at a borrower’s credit score and credit history—including their payment history—when making their decision.
  • A low debt-to-income ratio: Lenders may measure a borrower's ability to make loan payments by determining their debt-to-income ratio. It’s calculated by dividing monthly debt payments by gross monthly income.

Reasons to take out a home equity loan

Explore reasons for getting a home equity loan—plus situations you may want to avoid: 

Make home improvements

People sometimes use a home equity loan to fund home repairs and renovations. The benefits can be twofold: a more comfortable home now, and maybe a better price when it’s time to sell the home

They sometimes take out home equity loans for other reasons too—like for debt consolidation or to pay for large expenses like college tuition. Since failure to repay a home equity loan could result in foreclosure, the Consumer Financial Protection Bureau (CFPB) cautions against using one to pay off debt. It also recommends seeing a credit counselor to review alternative financing for those types of needs.

Home equity loan alternatives 

Take a look at some ways homeowners might be able to tap into the equity in their homes:

Home equity loan vs. home equity line of credit 

Like a home equity loan, a HELOC allows a homeowner to borrow money based on the equity in their home. But while a home equity loan gives the money to the homeowner in a lump sum, a HELOC is a form of revolving credit. It allows a homeowner to borrow money, repay it and then borrow again when they need to. 

While home equity loans typically have a fixed interest rate, HELOCs usually have an adjustable interest rate. This means a HELOC’s rate can fluctuate over time, which could affect monthly payments.

Home equity loan vs. cash-out refinance 

A cash-out refinance is similar to a home equity loan in that it allows homeowners to access their home’s equity as cash. A home equity loan involves taking out a second loan on an existing mortgage. But a cash-out refinance replaces an existing home mortgage with a new, bigger one—ideally with a better interest rate. The original mortgage is then paid off with the funds from the new mortgage, and the borrower receives cash for the difference.

Compared to a home equity loan, cash-out refinancing tends to offer a quicker turnaround time from applying for the loan to accessing the cash. But the assessed fees and percentage points on a cash-out refinance tend to be higher than a home equity loan. Plus the credit score requirements can be stricter for cash-out refinancing than for home equity loans.

Home equity loan FAQ

Still learning? Here are answers to some FAQ on home equity loans:

A major downside of a home equity loan is the potential for foreclosure—if a borrower can’t make their payments, they could lose their house. 

There are other considerations, too. For example, a home’s value could decline after the owner gets a home equity loan. If so, the home equity loan plus the balance on their original mortgage could equal more than the value of their home. 

Some home equity loans may also come with prepayment penalties. And like other types of loans, home equity loans generally come with fees. They can include an origination fee, an appraisal fee, title fees and filing fees.

Both types of loans are generally paid back over time in fixed monthly payments. One of the major differences is that personal loans may be unsecured, while home equity loans are usually secured with the home used as collateral. 

There are multiple ways a new loan could affect credit scores. Lenders may run a hard credit inquiry before offering a home equity loan, which may temporarily lower a borrower’s credit score. Home equity loans could also affect a person’s credit mix. On the other hand, making on-time payments on a home equity loan could help improve credit scores over time.

A home equity loan may be tax-deductible when it’s used to build, buy or improve a home. You can learn more by visiting the IRS page about home mortgage interest deductions.

Home equity loans in a nutshell

A home equity loan, like a home equity line of credit, is a way for homeowners to borrow against the equity in their homes. If you’re considering one, it could help to understand the potential risks, costs and repayment terms. 

Talking to an expert could help you understand more. And always remember what the CFPB says: “If you cannot pay back the HEL, the lender could foreclose on your home.”

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