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What Is a Home Equity Loan (HELOAN)?
Key takeaways
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A home equity loan is a fixed-rate, secured loan that turns equity into a lump sum, often up to 80% to 90% of the value of your home
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You repay over a set term with predictable payments, making it easy to use autopay and erasing concerns about rising interest rates
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Home equity loans are a popular option for making home repairs and renovations, debt consolidation, and emergencies
A home equity loan (HELOAN) is a fixed-rate loan that allows you to borrow against home equity—your home’s market value minus what you owe on your mortgage. For a HELOAN, lenders may let you borrow up to 80% of your home's equity, but some will go as high as 90%.
This article will explain how home equity loans work, what the benefits and risks are, how they differ from home equity lines of credit (HELOCs), and whether a home equity loan might be right for you.
How does a home equity loan work?
A HELOAN lets you borrow a specific amount of money based on home equity, usually up to a combined loan-to-value ratio of 80%. Once approved, you receive the funds in a single disbursement and repay the loan over a fixed term—often between 5 and 30 years.
You'll need to have the minimum equity required for a home equity loan, usually 15% to 20%, depending on the lender.
The key features of a home equity loan, which can be a type of second mortgage, include:
- One-time lump sum. Your loan is a fixed amount that you receive one time
- Fixed interest rate and APR. The interest rate stays the same for the life of the loan
- Predictable monthly payments. You know what you're going to pay each month, which helps with automatic payments and budgeting
- Set repayment schedule. The HELOAN repayment term is set when you obtain the loan. The terms typically range from 5 years (60 payments) to 30 years (360 payments)
- Your home is the collateral. Because your secured loan is back by your home as collateral, interest rates for HELOANs tend to be lower than rates for some other types of loans. However, this could put you at risk of foreclosure
What can a home equity loan be used for?
Experts say that one good use for a home equity loan is to finance home improvements, renovations, upgrades, and additions, because they will likely raise the value of your home, giving you even more equity.
But a home equity loan can be a solution for a variety of financial needs. It could help you:
- Make home repairs. This could include expenses like a new roof, furnace, or HVAC
- Consolidate unsecured debt. Home equity loan interest rates are typically lower than what you pay on credit cards
- Pay for college. You might be able to find a lower interest rate on a home equity loan than a private student loan
- Start a business. The interest rates may be lower than those available with a small business loan
- Take care of emergency expenses. Most HELOANs close in one to two weeks after an appraisal
What are some home equity loan benefits?
There are several reasons why home equity loans remain popular.
1. Fixed interest rate
HELOANs typically feature fixed interest rates. You don't have to worry about paying more in interest if inflation heats up and interest rates increase.
2. Predictable monthly payments
The loan is paid off on a set schedule with regular monthly payments. You know how much to budget for each month, and when the loan could be paid off.
3. Lower interest rates than unsecured loans
The average annual percentage rate (APR) on credit cards and personal loans typically is higher than home equity loan interest rates.
4. Ideal for large, one-time expenses
If you are planning a $20,000 kitchen renovation or a $10,000 wedding, a home equity loan may be a good choice.
5. Potential tax benefits
The interest paid on home equity loans could be deductible if the funds are used to buy, build or substantially improve a primary residence. A tax professional could advise you on how to apply this to your returns.
What are the drawbacks of a home equity loan?
Even with all of those benefits, there are aspects of a home equity loan that you will have to weigh carefully.
- The loan is secured by your house. Because your house serves as collateral, you could lose it if you're unable to make your payments
- You may be tempted to borrow more than you need or can afford to repay. Just because you can borrow $100,000 doesn't mean you should. You might avoid trouble if you determine what the money will be used for and borrow only what you need
- Closing costs and other fees may apply. Home equity loan closing costs may include an origination fee, a title search fee, an appraisal fee, and a credit report fee
- You pay interest on the entire amount, whether or not it's used. If you borrow $20,000 to renovate your kitchen and it costs only $15,000, you will still pay interest on the entire amount borrowed
HELOAN vs. HELOC: What’s the difference?
There are two home equity borrowing options, and it's good to understand a home equity loan vs. a HELOC.
HELOAN (home equity loan)
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Lump sum. You receive funds in a one-time payment with no further access to additional funds
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Fixed interest. HELOANs typically have a fixed interest rate
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Predictable payments. A fixed interest rate allows for fixed monthly payments, making automatic payments and budgeting easier
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Ideal for one-time costs. Projects for which you've set a budget, such as a home renovation, are prime candidates for home equity loans
HELOC (home equity line of credit)
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Revolving credit. As you pay back the principal, you can borrow those funds again
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Variable interest rate. HELOCs typically have variable interest rates, which can go up or down depending on the prime rate. Payments may differ month to month
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Borrow as needed. A HELOC is more like a credit card than a mortgage in the way you can access funds when you need them
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Interest-only during the draw period. HELOCs usually have a 10-year draw period during which you can borrow, followed by a repayment period. Many lenders offer interest-only payments during the draw period, which keeps payments lower
Is a HELOAN for you?
Find out whether a home equity loan is suitable for you by answering the following questions:
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Do you prefer a fixed rate, a one-time disbursement, and predictable monthly payments?
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Do you have a specific funding target for a project or financial need? HELOANs are especially popular with homeowners who want to finance home improvements or consolidate high-interest debt
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Are you comfortable using your home as collateral, with the risk of foreclosure if you can't make the payments?
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Do you need a lower-rate option for large expenses?
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Are you able to make the monthly payment for a home equity loan? A home equity loan calculator can tell you what the payments may be
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Do you have at least 15% to 20% equity in your home?
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Do you have a credit score of at least 680, regular income, and a solid credit history?
FAQs
A HELOAN is a fixed-rate loan that allows you to borrow against your home's equity, which is your home's market value minus what you owe on it.
You would receive a one-time disbursement and repay it over a fixed term (usually 5 to 30 years) with fixed monthly payments.
This is a secured home loan option, and your house serves as the collateral.
Common uses for HELOANs include major home projects like renovations, upgrades, and additions—all of which may boost your home equity.
Homeowners also use HELOANs to consolidate high-interest debt, pay college tuition, start a business, make major purchases, and pay large, unexpected bills. Because you could lose your home if you default on the loan, experts generally recommend against using a HELOAN for things like funding a vacation, buying a car, or paying daily expenses.
Most lenders may let you borrow up to 80% of the combined loan-to-value ratio (CLTV), which compares the loan amount to the equity on your house. Some will go higher, but it depends on the lender, how much equity you have in your home, and your creditworthiness.
For example, if your home is worth $400,000 and you owe $200,000 on your mortgage, you have a $200,000 in equity. If the maximum CLTV ratio is set at 80%, you could borrow up to 80% of $200,000, or up to $160,000.
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