How Does a Home Equity Loan Work?
A home equity loan is a way to convert equity to cash at a fixed interest rate, with a portion of your home equity funding the money you borrow. You can use the funds for virtually anything, from paying off credit cards to renovating your home.
We’ll cover how a home equity loan works, where to look for these loans and what to expect during the application, closing and repayment processes.
The home equity loan process
Getting a home equity loan is very similar to how you’d get a first mortgage, with a few important details to understand along the way:
- Qualification. The lender reviews your income, credit score and overall debt load to determine whether you qualify, how much you can borrow and what home equity loan rate you’ll receive.
- Valuation. A home appraiser verifies your home’s value so the lender can calculate how much equity you have and finalize your loan amount.
- Loan structure and terms. Once approved, your loan terms are set. Home equity loans are paid out in a single lump sum and repaid in equal monthly installments. Repayment terms typically range from five to 30 years.
- Closing. You pay closing costs, which can be deducted from your loan or paid out of pocket.
- Funding. The entire home equity loan balance is disbursed in a lump sum. There are no limitations on how you can use the funds, though certain uses can bring you tax benefits. Using a home equity loan for home improvements, for example, may allow you to deduct the interest you paid on that loan — but only if you used the funds to buy, build or substantially improve the home.
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The stakes are high with a home equity loan because it’s secured by your home. If you can’t make your payments, the lender could foreclose on your house and then sell it to recoup the money they lent you.
How much equity can I borrow from my home?
Most home equity lenders only let you tap up to 85% of your home’s value, or LTV. You can use LendingTree’s home equity calculator to quickly ballpark how much you can borrow based on that common limit.
Some lenders may set different maximums, but all lenders will represent their limit using a loan-to-value (LTV) ratio. It’s possible to find lenders who offer high-LTV home equity loans, which give you the opportunity to borrow all or almost all of your home’s equity. In those cases you may want to calculate your maximum loan amount by hand.
Let’s say you currently owe $250,000 on your home and your lender allows you to tap up to 95% of your home’s value. Your home was recently appraised at $350,000.
Remember: Most lenders will calculate your LTV ratio by combining your first mortgage and the second mortgage you’re applying for. That’s why we’ve subtracted your current mortgage balance in step two.
- Multiply your home’s value by 95% (0.95): $350,000 x 95% = $332,500
- Subtract your loan balance from the result: $332,500 – $250,000 = $82,500
- Your maximum home equity loan amount: $82,500
How much are home equity loan closing costs?
Home equity loan closing costs typically range between 2% to 6% of the loan amount. However, it’s not uncommon for lenders to offer no-closing-cost options.
Be sure to read the fine print and compare your options — not paying closing costs often means accepting a higher interest rate. You can also check whether your lender offers any special deals for borrowers who set up automatic payments.
Where can I get the best home equity loans?
Banks and credit unions are a solid bet for getting a home equity loan, but there are also online home equity lenders to consider as well. Ultimately, you should research lenders and comparison shop to get the best deal on a home equity loan.
How LendingTree helps you get your best loan
On LendingTree, you can fill out one form and immediately compare rates from our network of vetted home equity lenders — when banks compete, you win. Comparison shopping with three to five lenders on LendingTree can save you tens of thousands of dollars in the long run, according to our data.
Not sure where to start? Check out LendingTree expert picks for the best home equity lenders.
Home equity loan rates and terms
Rates
See current home equity loan rates on LendingTree today.
Home equity loan interest rates are typically higher than 30-year mortgage rates, home equity line of credit (HELOC) rates or cash-out refinance rates.
Home equity loan rates rise and fall with the financial markets just like rates for a first mortgage. You can check current home equity loan rates online or by calling home equity lenders in your area.
Compare current HELOC rates offered on LendingTree.
Terms
Home equity loan terms usually range between five and 10 years, but can go up to 30 years with some lenders. A longer loan term typically means more affordable monthly payments, while a shorter loan term means higher monthly payments because the same amount is divided across fewer months.
But the benefit of choosing a shorter loan term is that the borrower will pay less in interest over the life of the home equity loan.
Home equity loan requirements
Home equity loan requirements are a little more stringent than mortgage, refinance or cash-out refinance guidelines. Here’s a quick overview:
A maximum 43% DTI ratio
Home equity lenders divide your total debt by your income before taxes — a calculation called your debt-to-income (DTI) ratio — and generally set the maximum at 43%.
A minimum 620 credit score
Lenders are more likely to charge you a higher interest rate for a home equity loan if you’re near that minimum 620 score, and some may require a minimum between 660 and 680.
A maximum 85% LTV ratio
Some specialized home equity lenders set LTV ratios at 90% or higher, while most follow the 85% LTV maximum.
How to apply for a home equity loan
- Check how much you can borrow Most lenders let you borrow up to about 85% of your home’s value, minus what you still owe on your mortgage. You can use an online home equity loan calculator for a quick estimate and review your budget to make sure you can comfortably handle the monthly payment.
- Compare three to five lenders Get quotes from banks, credit unions and online lenders. Look at your loan estimates side-by-side to compare interest rates, loan terms, monthly payments and fees. Finding the best overall offer is about far more than simply finding the lowest rate.
- Apply and provide documentation Once you choose a lender, submit your application online, by phone or in person. You’ll need to share details about your income, debts and current mortgage, and the lender will pull your credit.
- Get a home appraisal Most lenders require an appraisal to confirm your home’s value. Prepare your home so it’s ready for the appraiser, as this step helps to determine your final loan amount.
- Close on your loan and receive funds If approved, you’ll review and sign the final paperwork and pay closing costs, which typically range from 2% to 6% of the loan amount. After a mandatory three-business-day waiting period, you’ll receive your lump sum.
Timeline: The full process usually takes two to eight weeks from application to funding.
Frequently asked questions
Yes, bad credit home equity loans are available from some lenders. However, be prepared for a much higher rate and less borrowing power than you’d see with loans for high-credit-score borrowers.
Using a home equity loan for home improvements is just like using any other funding source. Just make sure the interest rates and other loan terms suit your specific situation better than the other options available to you. Alternatives include HELOCs, personal loans, cash-out refinances and credit cards.
Yes, you may see a brief dip in your score when you apply for the loan.
Home equity loan closing costs are usually about 2% to 6% of your loan amount.
Most lenders require at least a 620 credit score to qualify for a home equity loan or HELOC.
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