How Do Home Equity Loans Work?

A home equity loan is a fixed-rate loan that borrows against your home’s equity. You borrow a lump sum and repay it at a fixed interest rate, which keeps your monthly payments predictable.^[1]

A home equity line of credit (HELOC) also borrows against the value of your home, but works more like a credit card. It offers flexible access to funds with a variable interest rate.

Before you decide to tap into your home’s equity, it’s important to understand how a home equity loan works, what it costs, how it differs from other equity products like HELOCs, and how it affects your house and finances.

How Home Equity Loans Work

A home equity loan (HELOAN) lets you borrow a portion of your home’s current value after subtracting what you still owe on your mortgage. You receive the funds up front and repay them over time in fixed, stable monthly installments.

Here’s how home equity loans work:

1. Build equity in your home. Pay down your current mortgage or benefit from rising home values.

2. Apply for a loan. Submit your financial information, credit history, income, and property details.

3. Home appraisal. A professional appraiser confirms your home’s current market value and submits the appraisal report to your lender.

4. Receive payout. You get a lump-sum payout after final approval, signing the loan documents, and paying closing costs.

5. Repay over loan term. Make fixed monthly mortgage payments until you pay off the loan.

Let’s say your home is worth $400,000 and you owe $250,000 on your primary mortgage. You may be able to borrow against part of your $150,000 home equity. Typically, you can’t borrow more than 80% of your home’s equity, so in this example, $120,000 would be the maximum you could borrow.

Home Equity Loan vs. HELOC vs. Cash-Out Refinance

Home Equity Loan Type	Interest Rate	Repayment Term	Draw Period	Best For
Home equity loan	Fixed	5–30 years	None, lump sum up front	Large, one-time purchases
Home equity line of credit (HELOC)	Variable	5–20 years after draw period ends	3–10 years	Ongoing access to funds
Cash-out refinance	Fixed or variable	Up to 30 years	None, lump sum up front	Paying off high-interest debt

Homeowners usually choose between a fixed-rate home equity loan or a flexible HELOC. A cash-out refinance is another option some borrowers use. It replaces your current mortgage with a larger one and gives you the difference in cash.^[2]

Let’s take a look at how each loan option differs and the pros and cons to consider.

Home equity loans

A home equity loan gives you a lump sum payout based on the market value of your home, minus the outstanding balance of your existing mortgage. Longer terms lower your monthly payments but increase the total interest you pay. Payments stay the same for the life of the loan.

Home equity loans are best for homeowners who want predictable payments for a one-time expense.

HELOCs

A HELOC lets you borrow money as needed during a draw period, usually with a variable rate and interest-only payments at first. You can reuse credit as you repay the balance. Once the repayment period starts, principal and interest payments are due, and you can no longer access funds.

HELOCs are best for homeowners who want flexibility and ongoing access to funds.

Cash-out refinance

A cash-out refinance replaces your primary mortgage with a new loan and gives you cash up front in a lump sum. Rates may be fixed or variable, and you can typically choose a repayment term of up to 30 years. Choosing a longer term or a higher interest rate may increase your total interest cost.

Cash-out refinancing is best for borrowers who want to refinance and access equity at the same time.

Home Equity Loan Rates, Terms, and Monthly Payments

Home equity loan rates currently range from 6% to 12%, but vary based on market conditions. Your rate depends on factors like your credit score, monthly income, debt levels, and the amount of equity you have.

Higher credit scores and lower loan-to-value (LTV) ratios usually get better rates. The LTV is the value of the home minus the remaining balance of your current mortgage.

These types of loans typically have higher rates than primary mortgages because they’re second liens, which means lenders take on more risk.^[3] Terms usually range from five to 30 years. Shorter terms mean higher monthly payments but less total interest, while longer terms lower your monthly cost but increase the total interest paid.

Home equity loan interest rates

Fixed rates stay the same for the life of the loan. Variable rates, which are more common with HELOCs, can change over time.

Lenders take on more risk with a second mortgage, like HELOANs, so they often charge higher rates. If you default, the primary lender gets paid first, so there’s a chance the second lender only gets some or none of the money you still owe.

You can usually secure a lower rate with a higher credit score, more available equity, or a shorter repayment term, as shown below.

Loan Type	Typical APR Range
Five-year home equity loan	7.90%–8.25%
10-year home equity loan	8.00%–8.50%
15-year home equity loan	8.05%–8.75%
30-year home equity loan	8.25%–9.00%

Home equity loan payments

Your monthly payment depends on your loan amount, annual percentage rate (APR), and loan term. Higher rates or shorter terms increase loan payments. Paying on time each month helps you avoid fees and protect your home from foreclosure risk.

Check out the table below to see how different loan amounts, rates, and terms affect the amount of money you’ll repay each month.

Example Loan Amount	Typical Rate	Loan Term	Estimated Monthly Payment
$25,000	8.25%	Five years	$510
$50,000	8.50%	10 years	$620
$75,000	8.75%	15 years	$750
$100,000	9.00%	20 years	$900

How to Calculate Your Home’s Equity

To calculate your home’s equity, subtract your mortgage balance from your home’s current property value.^[4] For example, if your home is worth $400,000 and you owe $250,000, you have $150,000 in equity.

Lenders use an appraisal or an automated valuation model to determine your home’s current value. Most allow you to borrow up to 80% of your home’s equity.

So, if your home is worth $400,000, and you have $250,000 left to pay on your mortgage, you have $150,000 in equity. You can borrow up to 80% of your equity. In this scenario, your maximum loan amount would be $120,000.

How much you can borrow against home equity varies by lender. Though 80% is most common, some lenders allow 90%, giving you more equity to tap.

How to Qualify for a Home Equity Loan

The home equity loan process starts with qualifying to ensure approval, then applying for the loan. Here’s the step-by-step process:

1. Research lenders. Compare loan options, rates, and home equity requirements.

2. Check your equity. Use your home equity calculation to confirm that you meet your chosen lender’s requirements.

3. Review your credit report. Make sure there aren’t any errors or inaccuracies. Dispute them if there are. Check your credit score; most lenders prefer a score of at least 620.

4. Evaluate your debt-to-income ratio (DTI). This is how much of your monthly income goes to pre-existing debts. Lenders typically want a DTI of 43% or less.

5. Gather documents. You’ll usually need to provide proof of income and homeowners insurance, plus mortgage, property tax, and bank statements.

6. Apply for the loan. Submit your application and supporting documents for underwriting.

7. Complete appraisal and closing. After the appraiser submits the appraisal report, the lender will finalize the loan. You’ll review and sign the loan documents, then receive funds.

Pros and Cons of Home Equity Loans

Home equity loans can be useful, but they’re not right for every situation. Weigh the benefits against the risks before borrowing.

Common Uses for Home Equity Loans

Homeowners use their home equity for many reasons, but these loans work best for planned, meaningful expenses or emergencies, not impulse or frivolous spending. Here are the most common uses for home equity loans:

• Home renovations or improvements: The most common use that can boost property value or make it easier to age in place. But projects can go over budget, which could max out your equity too soon.

• Debt consolidation: A loan can provide lower interest rates to help you get rid of high-interest debt. But you risk your home if you can’t repay.

• Funding education or emergency expenses: Can provide fast funding with an up front lump sum, but adds long-term debt that can be costly.

• Buying investment properties: You can expand your rental portfolio without coming up with a large cash down payment, but risk potential foreclosure on your primary residence and negative returns on your investment.

Home Equity Loan Alternatives

If a home equity loan doesn’t meet your needs, consider these alternatives:

• HELOC: Better for ongoing, fluctuating, or uncertain expenses.

• Cash-out refinance: May be worth it if you want to replace your high-interest mortgage and access cash.

• Personal loan: Doesn’t require collateral, so no risk of foreclosure, but usually comes with higher interest rates and shorter repayment terms.

• Credit cards: Often carry the highest interest — should only be an option for smaller purchases you can repay quickly.

• Reverse mortgage: Doesn’t require payments while living in the home, but requires full repayment once you no longer do. A reverse mortgage is available only to homeowners 62 or older and often has higher closing costs. The loan balance also increases as loans age, potentially reducing the inheritance for heirs.

FAQs About How Home Equity Loans Work