A home equity loan lets you borrow a lump sum of money against the value you’ve built in your home, and then repay it at a fixed interest rate over a set term. It works like a second mortgage: You apply, qualify based on your equity and financial profile, receive the funds, and make fixed monthly payments until the loan is paid off.
If you're a homeowner and need cash to start a business, consolidate credit card debt, cover medical expenses, or make a major purchase, a home equity loan may be a good option. These loans allow you to borrow against the amount of equity you have in your home. In addition, lenders typically offer lower interest rates than credit cards or personal loans because your home secures the loan.
If you’re considering a home equity loan, take a moment to understand how they work, what they cost, how to qualify, and how to decide whether one makes sense for your situation.
What is home equity?
Home equity is the portion of your home’s value that you own outright, the difference between what your home is worth and what you still owe on your mortgage.
For example, if your home is worth $250,000 and your remaining mortgage balance is $150,000, you have $100,000 in home equity. You can use that equity as collateral to borrow against it through a home equity loan or a home equity line of credit (HELOC).
How does home equity grow over time?
Your equity increases whenever your home’s market value rises or your mortgage balance decreases, or both.
There are four primary ways to build home equity:
- Making your regular mortgage payments reduces your outstanding balance each month, gradually increasing your ownership stake in the property.
- Making extra principal payments accelerates equity growth beyond your standard amortization schedule.
- Home improvements that add value, such as kitchen renovations, bathroom updates, or additions, increase your home’s market value, which increases your equity. See our guide on home improvements that increase property value for ideas worth considering.
- Rising property values in your local market increase your equity even without any action on your part.
How does a home equity loan work?
A home equity loan works like your original mortgage: You apply, get approved for a specific amount, receive the full amount upfront as a lump sum, and then make fixed monthly payments until you repay the loan in full.
Unlike a credit card or line of credit, a home equity loan gives you all the money at once. This makes it well-suited for one-time, defined expenses where you know the total cost upfront.
There are a few key mechanics of a home equity loan to understand:
- You receive the full loan amount at closing. There is no draw period or revolving access.
- The interest rate is fixed, so your monthly payment stays the same for the life of the loan.
- Loan terms typically range from five to 30 years, depending on the lender and your situation.
- Your home serves as collateral, which is why lenders can offer lower rates than unsecured loans.
How much can you borrow with a home equity loan?
Most lenders let you borrow up to 85% of your home’s value, minus your remaining mortgage balance. The exact amount depends on your lender’s policies, your credit profile, and your home’s appraised value.
Example calculation
- Home value: $300,000
- Maximum borrowable (85%): $300,000 × 0.85 = $255,000
- Remaining mortgage balance: −$100,000
- Maximum loan amount: $155,000
Before you apply, consider the amount you want to borrow and what you plan to use it for. Only borrow what you need as you’ll repay the loan, plus interest, over an extended period.
What are the benefits of a home equity loan?
Home equity loans offer predictable payments, lower interest rates than most unsecured borrowing, and access to a larger amount of money than a personal loan typically provides.
Key benefits include:
- Fixed interest rate means your payment never changes, making it easy to budget.
- Lower rates than credit cards and personal loans because your home secures the debt.
- Access to substantial funds based on the equity you’ve built.
- Potential tax deductibility of interest when you use funds to buy, build, or substantially improve your home. See IRS Publication 936 for details. A tax advisor can confirm whether this applies to your situation.
- One lump sum disbursement is useful when you have a defined, total expense.
What are the risks and drawbacks?
The most significant risk is foreclosure: If you stop making payments, your lender can foreclose on your home. Using a home equity loan to pay off other debt may lower your interest rate, but it also means your home is backing that debt. If payments become difficult, your home could be at risk.
Other drawbacks to consider:
- Your home is at risk if you cannot repay. This is not like missing a credit card payment. The stakes are higher.
- Closing costs and fees apply. Pay close attention to the annual percentage rate (APR), which reflects the true cost of borrowing, including the interest rate plus lender fees.
- Borrowing more than you need or using the funds for non-essential expenses can create long-term financial strain.
- Your equity decreases after you borrow against it, which matters if you plan to sell your home or refinance.
A home equity loan works best when the expense is clearly defined, necessary, and within a budget you can maintain over the loan term.
What does it cost to borrow with a home equity loan?
The interest rate is only part of the cost of a home equity loan. Other expenses, such as lender fees, closing costs, and appraisal fees, can affect what you pay overall. Checking the APR can help you compare your options more accurately.
When comparing loan options, look beyond the stated interest rate and review the APR, which includes the rate plus fees. Our mortgage loan calculator can help you understand how lenders calculate costs.
Questions to ask when reviewing loan costs:
- What is the APR?
- Are there origination fees or closing costs?
- Is there a prepayment penalty if I pay off the loan early?
- Are there annual fees?
The loan officers at Welch State Bank are happy to walk you through the full cost details before you decide.
How do you qualify for a home equity loan?
Qualifying for a home equity loan is similar to qualifying for your original mortgage. Lenders evaluate a number of factors:
| What lenders review | Why it matters |
|---|---|
| Home equity | Determines how much you can borrow |
| Credit score | Affects the interest rate you receive |
| Debt-to-income (DTI) ratio | Compares your monthly debt payments to your monthly income to help determine whether a new loan fits within your budget |
| Employment and income verification | Confirms you can repay the loan |
| W-2s or tax returns (2 years) | Documents income history |
| Recent pay stub with year-to-date income | Verifies current earnings |
| Bank and asset statements | Reflects financial stability |
| Records of existing debts (school loans, credit card balances, car payments, etc.) | Included in DTI calculation |
The minimum equity requirement varies by lender. Many require that you retain at least 15–20% equity in your home after the loan closes, which is why the maximum borrowing amount is typically capped at 85% of your home’s value.
If it has been a while since you bought your first home, our guide on what to expect when buying your first home can help refresh your understanding of the documentation process.
What is the difference between a home equity loan and a HELOC?
A home equity loan gives you a lump sum upfront with a fixed interest rate. A home equity line of credit (HELOC) works like a credit card. You draw funds as needed up to a limit, and the rate is typically variable.
The right choice depends on your situation:
- Choose a home equity loan if you have a specific, one-time expense with a known total — such as a roof replacement, medical procedure, or debt payoff.
- Consider a HELOC if you have ongoing or phased expenses — such as a multi-stage home renovation — where you want to draw funds as costs occur rather than borrow everything upfront.
| Home equity loan | Home equity line of credit (HELOC) | |
|---|---|---|
| How funds are received | Lump sum upfront | Draw as needed during draw period |
| Interest rate | Fixed | Typically variable (adjustable) |
| Monthly payment | Fixed, predictable | Varies based on amount drawn |
| Best for | One-time large expenses | Ongoing or phased expenses |
| Risk if unpaid | Lender may foreclose | Lender may foreclose |
If you’re not sure which fits your situation, the loan officers at Welch State Bank can help you think through the decision without any pressure.
