# Home Equity Loan: How It Works, Rates, Requirements, and Calculator

## What Is a Home Equity Loan?

A home equity loan—also known as an equity loan, home equity installment loan, or [second mortgage](https://www.investopedia.com/terms/s/secondmortgage.asp)—is a type of consumer debt. Home equity loans allow homeowners to borrow against the equity in their homes. The loan amount is based on the difference between the home’s current market value and the [homeowner’s mortgage balance due](https://www.investopedia.com/home-equity-loan-no-mortgage-5323867). Home equity loans tend to be fixed-rate, while the typical alternative, [home equity lines of credit (HELOCs)](https://www.investopedia.com/mortgage/heloc/), generally have variable rates.

### Key Takeaways

*   A home equity loan, also known as a home equity installment loan or a second [mortgage](https://www.investopedia.com/the-best-mortgage-lenders-11714101), is a type of consumer debt.
*   Home equity loans allow homeowners to borrow against the equity in their residence. 
*   Home equity loan amounts are based on the difference between a home’s current market value and the homeowner’s mortgage balance due.
*   Home equity loans provide one lump sum, whereas home equity lines of credit (HELOCs) offer borrowers revolving lines of credit.

![Home Equity Loan](https://www.investopedia.com/thmb/80ApcevDuzqJpr_LHPrtIxjpbRs=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/homeequityloan-e11896bf4ac1475a9806a55f92e0c312.jpg)

*Home equity loans are fairly easy to obtain, but they can put your home at risk of foreclosure. — Investopedia / Zoe Hansen*

## How a Home Equity Loan Works

Essentially, a home equity loan is akin to a mortgage, hence the name second mortgage. The [equity in the home](https://www.investopedia.com/terms/h/home_equity.asp) serves as [collateral](https://www.investopedia.com/terms/c/collateral.asp) for the [lender](https://www.investopedia.com/terms/l/lender.asp). The amount that a homeowner is allowed to borrow will be based partially on a [combined loan-to-value (CLTV) ratio](https://www.investopedia.com/terms/c/combinedloantovalue.asp) of 80% to 90% of the home’s [appraised](https://www.investopedia.com/terms/a/appraisal.asp) value. Of course, the amount of the loan and the rate of interest charged also depend on the borrower’s [credit score](https://www.investopedia.com/terms/c/credit_score.asp) and payment history.

> **Warning**
>
> Mortgage lending discrimination is illegal. If you think that you’ve been discriminated against based on race, religion, sex, marital status, use of public assistance, national origin, disability, or age, there are steps that you can take. One such step is to file a report with the Consumer Financial Protection Bureau (CFPB) or the United States Department of Housing and Urban Development (HUD).

Traditional home equity loans have a set [repayment](https://www.investopedia.com/terms/r/repayment.asp) term, just [like conventional mortgages](https://www.investopedia.com/repayment-terms-home-equity-loan-vs-mortgage-5323209). The borrower makes regular, fixed payments covering both [principal](https://www.investopedia.com/terms/p/principal.asp) and [interest](https://www.investopedia.com/terms/i/interest.asp). As with any mortgage, if the loan isn't paid off, the home could be sold to satisfy [the remaining debt](https://www.investopedia.com/get-home-equity-back-when-pay-off-loan-5323176).

A home equity loan can be a good way to [convert the equity you’ve built up](https://www.investopedia.com/home-equity-loan-maximum-5323470) in your home into cash, especially if you invest that cash in renovations that increase your home's value. However, always remember that you’re putting your home on the line—if real estate values decrease, you could end up owing more than the property is worth.

Should you want to relocate, you might end up losing money on the sale of the home or be unable to move. And if you’re getting the loan [to pay off credit card debt](https://www.investopedia.com/home-equity-loan-pay-off-debt-5270570), resist the temptation to run up those credit card bills again. Before doing something that puts your house in jeopardy, weigh all of your options.

> “If considering a home equity loan for a large amount, be sure to [compare rates](https://www.investopedia.com/lowest-home-equity-loan-rate-lenders-5323883) on multiple loan types. A [cash-out refinance](https://www.investopedia.com/terms/c/cashout_refinance.asp) may be a better option than a home equity loan, depending on how much you need.”

—[Marguerita Cheng](https://www.investopedia.com/marguerita-cheng-4684136), CFP, Chief Executive Officer, Blue Ocean Global Wealth

## Special Considerations

Home equity loans exploded in popularity after the [Tax Reform Act of 1986](https://www.investopedia.com/terms/t/taxreformact1986.asp) because they provided a way for consumers to get around one of its main provisions: the elimination of deductions for the interest on most consumer purchases. The act left in place one big exception: interest in the service of residence-based debt. 

However, the [Tax Cuts and Jobs Act of 2017](https://www.investopedia.com/taxes/how-gop-tax-bill-affects-you/) suspended the deduction for interest paid on home equity loans and HELOCs until 2026—unless, according to the [Internal Revenue Service (IRS)](https://www.investopedia.com/terms/i/irs.asp), “they are used to buy, build or substantially improve the taxpayer’s home that secures the loan.” For example, the interest on a home equity loan [used to consolidate debts](https://www.investopedia.com/home-equity-loan-bad-uses-5322850) or pay for a child’s college expenses isn't tax deductible.

As with a mortgage, you can ask for a [good faith estimate](https://www.investopedia.com/terms/g/good_faith_estimate.asp), but before you do, make your own honest estimate of your finances. “You should have a good sense of where your credit and home value are [before applying](https://www.investopedia.com/how-long-to-get-home-equity-loan-5323851), in order to save money,” says [Casey Fleming](https://www.linkedin.com/in/casey-fleming-6778523/), author of _The Loan Guide: How to Get the Best Possible Mortgage_. “Especially on the appraisal \[of your home\], which is a major expense. If your appraisal comes in too low to support the loan, the money is already spent”—and there are no refunds for not qualifying.

Before signing—especially if you’re using the home equity loan for [debt consolidation](https://www.investopedia.com/terms/d/debtconsolidation.asp)—run the numbers with your bank and make sure that the loan’s [monthly payments](https://www.investopedia.com/payment-on-usd500k-home-equity-loan-5270146) will indeed be lower than the combined payments of all your current obligations. Even though home equity loans have lower interest rates, your term on the new loan could be longer than those of your existing debts.

> **Important**
>
> The interest on a home equity loan is only tax deductible if the loan is used to buy, build, or substantially improve the home that secures the loan.

## Home Equity Loans vs. HELOCs

Home equity loans provide a single [lump-sum payment](https://www.investopedia.com/terms/l/lump-sum-payment.asp) to the borrower, which is repaid over a set period of time (generally 5 to 15 years) at an [agreed-upon interest rate](https://www.investopedia.com/home-equity-rate-trends-5323142). The payment and interest rate remain the same over the lifetime of the loan. The loan must be repaid in full if the home on which it's based is sold.

A HELOC is a revolving line of credit, much like a credit card, that you can draw on as needed, pay back, and then draw on again, for a term determined by the lender. The [draw period](https://www.investopedia.com/heloc-draw-period-definition-5211694) (5 to 10 years) is followed by a repayment period when draws are no longer allowed (10 to 20 years). HELOCs typically have a variable interest rate, but some lenders offer [fixed-rate options](https://www.investopedia.com/mortgage/heloc/fixed-rate-option/).

## Advantages and Disadvantages of a Home Equity Loan

There are a number of key [benefits to home equity loans](https://www.investopedia.com/can-i-use-a-home-equity-loan-to-buy-another-house-5200330), including cost, but there are also drawbacks.

### Advantages

Home equity loans provide an easy source of cash and [can be valuable tools for responsible borrowers](https://www.investopedia.com/pros-cons-home-equity-loan-5271238). If you have a steady, reliable source of income and know that you'll be able to repay the loan, then low-interest rates and possible tax deductions make home equity loans a sensible choice.

[Obtaining a home equity loan](https://www.investopedia.com/home-equity-lender-considerations-5323635) is quite simple for many consumers because it's a secured debt. The lender runs a credit check and orders an appraisal of your home to determine your [creditworthiness](https://www.investopedia.com/terms/c/credit-worthiness.asp) and the CLTV.

The interest rate on a home equity loan—although higher than that of a first mortgage—is much lower than that of credit cards and other consumer loans. That helps explain why a primary reason that consumers borrow [against the value of their homes](https://www.investopedia.com/home-equity-loan-lien-against-your-title-5235492) via a fixed-rate home equity loan is to pay off credit card balances.

Home equity loans are generally a good choice [if you know exactly how much you need to borrow and for what](https://www.investopedia.com/using-home-equity-to-start-a-business-5323469). You’re guaranteed a certain amount, which you receive in full at closing. “Home equity loans are generally preferred for larger, more expensive goals such as remodeling, paying for higher education, or even debt consolidation because the funds are received in one lump sum,” says [Richard Airey](https://www.linkedin.com/in/rickairey/), senior loan officer with CrossCountry Mortgage LLC in Portland, Maine.

### Disadvantages

The main problem with home equity loans is that they can seem like an all-too-easy solution for a borrower who may have fallen into a perpetual cycle of spending, borrowing, spending, and sinking deeper into debt. Unfortunately, this scenario is so common that lenders have a term for it: [reloading](https://www.investopedia.com/terms/r/reloading.asp), which is basically the habit of taking out a loan to pay off existing debt and free up additional credit, which the [borrower then uses to make additional purchases](https://www.investopedia.com/reverse-mortgage-pros-and-cons-5209641).

Reloading leads to a spiraling cycle of debt that often convinces borrowers to turn to home equity loans offering an amount worth 125% of the equity in the borrower’s house. This type of loan often comes with higher [fees](https://www.investopedia.com/home-equity-loan-fees-5323666): Because the borrower has taken out more money than the house is worth, the loan isn't fully secured by collateral. Additionally, know that the interest paid on the portion of the loan that's above the value of the home is never tax deductible.

When applying for a home equity loan, there can be some temptation to borrow more than you immediately need because you only get the payout once and don’t know if you’ll qualify for another loan in the future. If you're contemplating a loan worth more than your home, it might be time for a reality check. Were you unable to live within your means when you owed only 100% of the equity in your home? If so, then it'll likely be unrealistic to expect to be better off when you increase your debt by 25%, plus interest and fees. This could become a slippery slope to [bankruptcy](https://www.investopedia.com/terms/b/bankruptcy.asp) and [foreclosure](https://www.investopedia.com/terms/f/foreclosure.asp).

![Home Equity Loan Pros and Cons](https://www.investopedia.com/thmb/GAHSv79vCER4LPwIrO0RvD0_GE4=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/dotdash-INV-infographic-Home-Equity-Loan-v1-9ae3dc9a5cc141d5a25ed2975c08ea1c.jpg)

*— Investopedia / Sabrina Jiang*

## Home Equity Loan Requirements

Each lender has its own requirements, but to get approved for a home equity loan, most borrowers will generally need:

*   Equity in their home greater than 20% of their home’s value
*   Verifiable income history for two or more years
*   A credit [score greater than 600](https://www.investopedia.com/home-equity-loan-credit-score-requirement-5270516)

Though it's possible to get approved for a home equity loan without meeting these requirements, expect to pay a much higher interest rate through a lender that specializes in [high-risk borrowers](https://www.investopedia.com/terms/r/riskbased-pricing.asp).

> **Tip**
>
> Determine the current balance of your mortgage and any existing home equity loans or HELOCs by finding a statement or logging on to your lender’s website. Estimate your home’s current value by comparing it with recent sales in your area or using an estimate from a site like Zillow or Redfin. Be aware that their value estimates aren't always accurate, so adjust your estimate as needed considering the current condition of your home. Then divide the current balance of all loans on your property by your current property value estimate to get your current equity percentage in your home.

Rates assume a loan amount of $25,000 and a loan-to-value (LTV) ratio of 80%. HELOC rates assume the interest rate during credit line initiation, after which rates can change based on market conditions.  

### Example of a Home Equity Loan

Say you have an auto loan with a balance of $10,000 at an interest rate of 9% with two years remaining on the term. Consolidating that debt to a home equity loan at a rate of 4% with a term of five years [would actually cost you more money](https://www.investopedia.com/home-equity-loan-suitability-5323164) if you took all five years to pay off the home equity loan. Additionally, remember that your home is now collateral for the loan instead of your car. Defaulting could result in its loss, and losing your home would be significantly more catastrophic than surrendering a car.  

## How Does a Home Equity Loan Work?

A home equity loan is a loan for a set amount of money, repaid over a set period that uses the equity you have in your home as collateral for the loan. If you are unable to pay back the loan, [you may lose your home to foreclosure](https://www.investopedia.com/can-home-equity-loan-enter-foreclosure-5235302).

## Are Home Equity Loans Tax Deductible?

The interest paid on a home equity loan can be tax deductible if the proceeds from the loan are used to “buy, build, or [substantially improve](https://www.investopedia.com/how-to-pay-for-home-renovations-8609156)” your home. However, with the passage of the Tax Cuts and Jobs Act and the increased [standard deduction](https://www.investopedia.com/terms/s/standarddeduction.asp), itemizing to deduct the interest paid on a home equity loan may not lead to savings for most filers.

## How Much Home Equity Loan Can I Get?

For well-qualified borrowers, the limit of a home equity loan is the amount that gets the borrower to a combined loan-to-value (CLTV) of 90% or less. This means that the total of the balances on the mortgage, any existing [home equity lines of credit (HELOCs)](https://www.investopedia.com/applying-for-a-home-equity-loan-5198551), any existing home equity loans, and the new home equity loan cannot be more than 90% of the appraised value of the home. For example, someone with a home that was appraised at $500,000 with an existing mortgage balance of $200,000 could take out a home equity loan for up to $250,000 if they're approved.  

## Can You Have a HELOC and a Home Equity Loan Simultaneously?

You can have both a HELOC and a home equity loan at the same time, provided you have enough equity in your home, in addition to the income and credit to get approved for both.

## What Is a HELOC Loan?

A HELOC loan doesn’t exist. The term is a combination of two existing different loan products: A HELOC and a home equity loan.

## The Bottom Line

A home equity loan can be a better choice financially [than a HELOC](https://www.investopedia.com/financial-edge/0911/is-taking-out-a-heloc-right-for-you.aspx) for those who know exactly how much equity they need to pull out and want the security of a fixed interest rate. Borrowers should [take out home equity loans](https://www.investopedia.com/get-home-equity-loan-5324093) with caution when consolidating debt or [financing home repairs](https://www.investopedia.com/home-equity-loan-finance-home-repairs-5324792). It's easy to end up [underwater](https://www.investopedia.com/terms/u/underwater-mortgage.asp) on a mortgage if too much equity is pulled out, leaving a borrower with [ruined credit](https://www.investopedia.com/debt-consolidation-hurt-credit-8426913) and a home in foreclosure.  

> **Article Sources**
>
> 1.  Congress.gov. “[H.R.3838 — Tax Reform Act of 1986](https://www.congress.gov/bill/99th-congress/house-bill/3838).”
>     
> 2.  Internal Revenue Service. “[Interest on Home Equity Loans Often Still Deductible Under New Law](https://www.irs.gov/newsroom/interest-on-home-equity-loans-often-still-deductible-under-new-law).”
>     
> 3.  Internal Revenue Service. “[Publication 936: Home Mortgage Interest Deduction](https://www.irs.gov/pub/irs-pdf/p936.pdf),” Pages 9–10.
>     
> 4.  Federal Trade Commission: Consumer Advice. “[Home Equity Loans and Home Equity Lines of Credit](https://www.consumer.ftc.gov/articles/home-equity-loans-and-home-equity-lines-credit).”