Borrowing against the equity in your home is a great way to tap into a source of funding when you need it. Here’s what you’ll want to know about home equity loans. 

What is a home equity loan? 

A home equity loan (HEL) is a secured loan allowing homeowners to borrow against the equity in their home. The loan amount is based on the difference between the home’s current market value and the homeowner’s outstanding mortgage balance, and it provides the borrower with the funds they want in one lump sum.

How a home equity loan works  

You can take a home equity loan out against the equity you’ve built up in your home, essentially borrowing against its value, minus what you still owe on your mortgage. A lender will typically want you to have an 80 percent loan-to-value (LTV) ratio once your home equity loan has been approved. 

Home equity loans generally have a fixed interest rate, so budgeting for the payments is easy to do. The monthly payment and interest rate will remain fixed over the life of the loan, which can run from 5 to 30 years. 

A HEL can be a great option for borrowers with a one-time or straightforward cash need.

Are there any costs associated with home equity loans?

As with home loans, there are closing costs, which include any fee incurred when originating, writing, closing, and recording a loan. Some lenders advertise no-fee home equity loans, but these generally have higher interest rates, which offset any gains. 

The pros and cons of home equity loans

The pros of a home equity loan include: 

  • The amount of interest paid toward a home equity loan may be tax-deductible.
  • Interest rates on HELs are generally lower than those provided by credit cards or unsecured loans. 

The cons of a home equity loan include: 

  • Using your home as collateral for the loan means risking foreclosure and home loss if you default. 
  • If your home value declines over the loan term, you may end up owing more than it’s worth. 
  • You’ll need to pay closing costs and other fees on the loan. 

Weigh all factors carefully before determining if a home equity loan is best for your needs.  

Your Turn: Have you taken out a home equity loan?