A home equity loan allows you to borrow against the value of your home. You can receive a portion of your home’s equity — the difference between the amount owed on your mortgage and your home’s market value — in cash. For example, if your home is worth $250,000 and your mortgage balance is $150,000, you have $100,000 in equity.
Home equity loans allow homeowners to access their equity in a lump sum that can be used for a variety of purposes, including home improvements and college tuition payments. Home equity loans usually have fixed interest rates.
Also known as second mortgages, home equity loans are repaid monthly — just like the first mortgage on your home. If you’re still repaying your first mortgage and decide to borrow against your available equity, you would be responsible for both your existing mortgage payment and the home equity loan payment each month until they’re paid in full.
The pros and cons of borrowing a home equity loan
If you’re interested in getting a home equity loan, consider the following benefits and drawbacks.
Home equity loan interest rates are typically lower than rates for credit cards and personal loans. This is especially important if you’re weighing whether to use a home equity loan or a personal loan to consolidate your existing debt.
If you use a home equity loan to buy, build or substantially improve your home, the interest you pay on that loan is tax-deductible. The Tax Cuts and Jobs Act of 2017 allows homeowners to deduct interest paid on mortgages, home equity loans and home equity lines of credit (HELOCs) — up to a combined total of $750,000. For married homeowners filing their taxes separately, the limit is $375,000. However, interest paid on home equity loans used for debt consolidation isn’t tax-deductible.
Home prices are still on the rise in the majority of the U.S., so there’s a chance your home is worth more than when you bought it. If that’s the case, you may have more equity than the amount you’ve built from paying down your mortgage, which means you can possibly borrow more than expected. The best way to learn your home’s value is through a home appraisal.
Home equity loans don’t just come with interest expenses. There are also closing costs, which can range from 2-5% of the loan amount.
There’s also a limit to how much of your home equity can be borrowed. Most lenders only allow you to borrow up to 85% of your available equity. Use our home equity loan calculator below to get an idea of the amount you might be eligible to borrow.
Your house is used as collateral when you take out a home equity loan, just as it is on your first mortgage. So if you fail to repay the loan, you’re putting your home at risk of foreclosure.
Regardless of whether you use the full amount of the money borrowed, you’re on the hook for repaying the full amount. If you’d rather only pay for what you use, you might consider a HELOC instead.
Home equity loans differ from home equity lines of credit
A home equity loan isn’t the same as a HELOC. A HELOC is a revolving line of credit that works similarly to a credit card, except the loan is backstopped by your home’s equity. Your lender approves you for a certain amount, which you can spend as needed. You make payments on what you borrow rather than the total line of credit.
For a more in-depth understanding, check out the differences between home equity loans and HELOCs.
Should you get a home equity loan?
Before you apply for a home equity loan, be clear on the qualifications and whether it makes sense for your financial situation.
Once you’ve made the decision to tap your home’s equity, be sure to live by these seven rules.