A home equity loan is a financial product that allows you to borrow against the value of your home. You’re able to receive in cash a portion of your home’s equity, or the difference between the amount owed on your mortgage and your home’s market value. For example, if your home is worth $250,000 and your current mortgage balance is $150,000, then you have $100,000 in equity.
Home equity loans allow homeowners to access their equity in a lump sum of cash, which may be used for a variety of purposes, including home improvements and college tuition expenses. These types of loans usually have fixed interest rates, are fully amortized and repaid in fixed monthly installments.
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, for example.
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 2017 Tax Cuts and Jobs Act allows homeowners to deduct interest paid on both mortgages and home equity loans and lines of credit — up to a combined total of $750,000. For married homeowners filing their taxes separately, the limit is $350,000. Interest paid on home equity loans used for debt consolidation isn’t tax-deductible, however.
Home equity loans don’t just come with interest expenses — there are also closing costs, which can range from 2% to 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 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.
Home equity loans differ from home equity lines of credit
A home equity loan isn’t the same as a home equity line of credit, commonly called 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 actually borrow, rather than the total line of credit.
Read our explainer on the differences between home equity loans and HELOCs for a more in-depth understanding.
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 home equity rules.