Rates, Pros, Cons, and How to Qualify

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• A home equity loan is a second mortgage that uses your home as collateral.
• Most lenders will allow you to borrow up to a combined ratio of 80% to 90% of your home’s value.
• You could lose your home if you fail to make your monthly payments. 

If you’re considering making improvements to your home, need help paying for your child’s college, or facing some other major expense, using a home equity loan could be a way to get your hands on a large sum of cash. 

For many homeowners, a home equity loan could give them access to more money than any other type of loan. Plus, these loans often come with better interest rates and terms than other forms of debt, like credit cards and personal loans.

But home equity loans come with their fair share of risks, as well. Here’s what you need to know about home equity loans before you start contacting lenders and filling out loan papers.

What is a home equity loan?

Definition

A home equity loan is a type of second mortgage that uses your home as collateral and allows you to borrow from your equity. 

For example, if your home is worth $250,000 and you owe $100,000 on your mortgage, you currently have $150,000 of “equity” in your home. A home equity loan lets you borrow a portion of that amount.

With home equity loans, you can typically borrow up to 80 to 90% of your home’s value — minus the balance on your main mortgage loan. You’ll get this money in cash, as a lump sum after closing, and then make equal monthly payments until the loan is paid back. You typically have five to 30 years to do so.

Keep in mind that home equity loans use your home as collateral, as with other mortgage loans. This means you could lose your home if you don’t make payments.

Second mortgage

Home equity loans are a type of second mortgage, meaning they’re a mortgage that’s in addition to your main one. They come with a second monthly payment. 

HELOCs — or home equity lines of credit, are another type of second mortgage, though they work differently. (More on this later on). 

How does a home equity loan work?

Taking out a home equity loan is similar to taking out a regular mortgage, with a few key differences. Here’s how to get a home equity loan: 

Borrowing process

To get a home equity loan, you’ll need to apply with a lender and submit financial documentation, like tax returns, W-2s, bank statements, and more.

The lender will then order an appraisal to determine the home’s value and how much equity you have to borrow from. 

From there, your lender will underwrite the loan, and schedule you a closing date. This is when you’ll pay your closing costs, sign the final paperwork, and get your funds.

Repayment terms

Home equity loans come with a variety of term options. You can typically choose anywhere between five- and 30-year repayment terms.

Most home equity loans have fixed interest rates. This means your rate — and your monthly payment — will remain the same the entire time you have the loan.

Interest rates in 2024

Interest rates vary widely by lender and borrower. Your credit score, loan amount, equity, and other factors will influence what rate you get, but generally speaking, home equity loan rates in 2024 average between 6.75% and 9%.

Pros and cons of home equity loans

It’s important to consider both the advantages and the disadvantages of a home equity loan before taking one out. These include:

Who qualifies for a home equity loan?

Eligibility requirements for home equity loans depend on the lender. Here’s what you can generally expect to need in order to qualify:

Equity requirements

Most lenders require you to retain at least 10 to 20% of your home’s value. This means your home equity loan balance and your main mortgage balance can’t come to more than 80-90% of your home’s value.

Credit score requirements

Lenders require good credit to take on a home equity loan, as they’re riskier than first mortgages are. You will usually need at least a 620 to qualify, though some lenders may require higher scores.

Income and debt-to-income ratio

You’ll need stable income and a manageable debt-to-income ratio to qualify for a home equity loan. Usually, this is a 43% DTI or below, meaning your total debt payments — including your new home equity loan payment — must amount to 43% or less of your monthly income.

Home equity loan vs. home equity line of credit (HELOC)

A HELOC is another type of second mortgage that you might consider if you need cash. Here’s how the two differ.

Key differences

A home equity line of credit (HELOC) is similar to a home equity loan in that both types of debt involve the homeowner borrowing against their home’s value. However, a HELOC operates more like a credit card. You get a credit limit that you can borrow against repeatedly for a set amount of time called the “draw period.”

Once the “draw period” on a HELOC ends, the credit line will no longer be accessible and regular payments begin. HELOC terms can vary, but they often have five- to 10-year draw periods, followed by a 10- to 20-year repayment period. Unlike a home equity loan or home improvement loan, a HELOC typically comes with a variable interest rate.

HELOCs are usually best if you’re not sure how much money you need or you need cash over an extended period of time. Home equity loans are best if you want a fixed rate and consistent monthly payment.

FAQs

Home equity loans: Conclusion

Home equity loans let you borrow from your home equity loans and can be a useful tool for some homeowners. Just make sure to consider the rate and terms you’ll get, your budget, and the risks of home equity loans. If you’re unable to make your payments, you could risk foreclosure.

Finally, be sure to compare the best home equity loan lenders before taking one out. Rates, terms, and qualifying requirements can vary from one company to the next.