What is a home equity loan?
A home equity loan often called an equity loan, installment loan, or second mortgage, is a consumer debt. Home equity loans let homeowners borrow against their equity. The loan amount derives from the difference between the home’s market value and the homeowner’s mortgage balance. Most home equity loans are fixed-rate, but HELOCs often have variable rates.
Home Equity Loan Process
Home equity loans are like mortgages; thus, they are called second mortgages. Equity in the residence acts as security for the lender. Homeowners can borrow subject to a combined loan-to-value (CLTV) ratio of 80% to 90% of the appraised value. The loan size and interest rate depend on the borrower’s credit score and payment history.
Mortgage loan discrimination is unlawful. You can take action if you feel discriminated against due to race, religion, sex, marital status, national origin, handicap, or age. One approach is to report to the Consumer Financial Protection Bureau or the U.S. Department of Housing and Urban Development.
Traditional home equity loans, like conventional mortgages, have a fixed payback duration. Regular, set payments cover both principal and interest for the borrower. Unpaid mortgages may result in the home’s sale to cover the outstanding debt.
Consider a home equity loan to convert your home equity into cash, mainly if you invest it in upgrades that boost its worth. Remember that you’re risking your home—if real estate values drop, you might owe more than it’s worth.
You may lose money selling the home or be unable to move. If using the loan to pay off credit card debt, avoid re-accumulating debt. Before risking your home, consider all your choices.
Consider comparing rates on several loan types when considering a big home equity loan. Depending on your needs, a cash-out refinance may be preferable to a home equity loan.
Marguerita Cheng, Certified Financial Planner, Blue Ocean Global Wealth
Special Considerations
After the Tax Reform Act of 1986, home equity loans gained popularity as a mechanism to circumvent the loss of interest deductions on most consumer purchases. One major exception was interest on residential debt.1
The Tax Cuts and Jobs Act of 2017 stopped the deduction for home equity loans and HELOC interest until 2026 unless used to buy, develop, or substantially enhance the taxpayer’s house. For instance, home equity loan interest for debt consolidation or education expenditures is not tax deductible.
Before requesting a good-faith estimate, establish an honest assessment of your funds, like with a mortgage. “Know your credit and home value before applying to save money,” advises Casey Fleming, branch manager at Fairway Independent Mortgage Corp. and author of The Loan Guide: How to Get the Best Possible Mortgage. “Especially your home’s expensive appraisal. You cannot get a refund if your assessment is too low to justify the loan.
Before signing, verify with your bank that the monthly payments of a home equity loan for debt consolidation would be lower than the sum of all your present liabilities. Even though home equity loans offer lower interest rates, the new loan may last longer than your other obligations.
The interest is tax deductible if used to buy, develop, or substantially enhance the home that secures a home equity loan.2
Comparing HELOCs to Home Equity Loans
Home equity loans offer a lump sum payment to the borrower, payable over a defined period (usually 5–15 years) at an agreed-upon interest rate. Payment and interest rates stay the same during the loan. The sale of the residence must repay the debt in full.
Like a credit card, a HELOC is a revolving line of credit you may use, pay off, and use again for a lender-determined duration. After a five- to 10-year draw term, a 10- to 20-year payback period follows.HELOCs usually have variable interest rates, although some lenders provide fixed-rate choices.
Home Equity Loan Pros and Cons
Home equity loans have several advantages, including cost, but also downsides.
Advantages
Home equity loans provide a convenient way for respectable consumers to get cash. If you have a stable income and can repay the loan, home equity loans are a good option due to their low interest rates and potential tax benefits.
Acquiring a home equity loan is easy due to its secured nature. The lender checks your credit and gets a house appraisal to establish your creditworthiness and CLTV.
Although more significant than a first mortgage, a home equity loan has a lower interest rate than credit cards and other consumer loans. A common incentive for people to choose fixed-rate home equity loans is to pay off credit card debt.
Home equity loans are ideal if you know the amount and purpose of the loan. You will receive your promised amount in full upon closing. Richard Airey, senior loan officer at Integrity Mortgage LLC in Portland, Maine, recommends home equity loans for larger, more expensive goals like renovation, higher education, or debt consolidation due to their lump-sum funding.
Disadvantages
The primary issue with home equity loans is that they may appear like a simple answer for borrowers who keep spending, borrowing, and getting into debt. Reloading, the practice of borrowing to pay off debt and free up credit for future purchases, is so frequent that lenders have a phrase for it.
Reloading creates a debt cycle that pushes borrowers to seek home equity loans for 125% of their home’s equity. This loan typically has higher fees: The loan lacks collateral since the borrower borrowed more than the house is worth. Interest on the loan portion above the home’s value is not tax deductible.3
When qualifying for a home equity loan, it might be tempting to borrow more than you need because you only get the payoff once and don’t know whether you’ll qualify again.
Consider a reality check before taking out a loan for more than your home. Could you not live within your means with 100% home equity? If so, increasing your debt by 25% plus interest and fees will unlikely improve your situation. A slippery slope to bankruptcy and foreclosure may occur.
Home equity loan requirements
The requirements for a home equity loan vary by lender, but usually borrowers need:
- Equity above 20% of home value
- 2+ years of income verification
- A credit score of 600
Obtaining a home equity loan without meeting these standards may result in higher interest rates from a lender specializing in high-risk borrowers.
Find a statement or visit your lender’s website to check the balance of your mortgage, second mortgages, HELOCs, and home equity loans. Compare previous sales in your region or use Zillow or Redfin to determine the worth of your house. Be careful that their property worth estimations may not be correct, so modify accordingly based on their actual condition. Divide the current balance of all debts on your property by its estimated worth to find your home’s equity percentage.
| Average Home Equity Interest Rates | ||
| Loan Type | Average Rate | Range |
| 15-year fixed | 5.82% | 2.99%–9.03% |
| 10-year fixed | 5.60% | 2.99%–9.99% |
| 5-year fixed | 5.28% | 2.50%–9.99% |
| HELOC | 5.61% | 3.50%–8.63% |
Rates assume a $25,000 loan and an 80% LTV. At the beginning of the credit line, HELOC rates assume the interest rate, but market conditions might modify them.
Example of Home Equity Loan
Say you have a $10,000 vehicle loan with two years left at 9% APR. Combining debt with a 4% home equity loan over five years might result in higher costs if paid in full. Remember that your home now secures the loan, not your automobile. Defaulting may cost you your house, which would be worse than losing a car.
How does a home equity loan work?
Home equity loans usHouser home’s equity as security for a set amount, fixed-term loan. If you cannot repay the loan, you risk losing your property to foreclosure.4
Are home equity loans tax-deductible?
house equity loan interest can be tax deductible if used to “buy, build, or substantially improve” a house. Since the Tax Cuts and Jobs Act boosted the standard deduction, itemizing home equity loan interest may not result in savings for most taxpayers.
Get how much home equity loan?
A home equity loan maximum for well-qualified applicants is 90% or less of the combined loan-to-value (CLTV). This implies that the mortgage, HELOCs, home equity loans, and new home equity loans cannot exceed 90% of the home’s appraised value. If accepted, a homeowner with a $500,000 house and a $200,000 mortgage simultaneously a home equity loan.
Can a HELOC and a home equity loan coexist?
Yes. If you have adequate home equity, income, and credit, you can receive a HELOC and a home equity loan at the same time.
HELOCs are loans.
No HELOC loans exist. This name combines two loan products: a home equity line of credit (HELOC) and a home equity loan.
The Verdict
If you know how much equity you need and want a set interest rate, a home equity loan may be better than a HELOC. Borrowers should use prudence while consolidating debt or funding home repairs using home equity loans. Excessive equity withdrawals can lead to mortgages going underwater, resulting in damaged credit and foreclosure.
Conclusion
- Consumer debt includes equity loans, often installment or second mortgages.
- Home equity loans let homeowners borrow against their equity.
- The gap between a property’s market value and its mortgage debt determines home equity loan amounts.
- Home equity lines of credit and fixed-rate loans are available.
- Fixed-rate home equity loans provide borrowers with a flat payment, while HELOCs offer ongoing credit.
