Home Equity Loan: What It Is and How It Works

A home equity loan (also called a home equity installment loan or second mortgage) lets homeowners borrow against the equity in their homes. It typically provides a one-time lump sum, repaid over a fixed term with a fixed interest rate, using the home as collateral.

Key takeaways

• A home equity loan is secured by your home and repaid in fixed monthly payments of principal and interest.
• Loan size depends on your home’s appraised value, outstanding mortgage balance, and combined loan-to-value (CLTV) limits (commonly up to about 80–90% CLTV for well-qualified borrowers).
• Home equity loans give a lump sum; a HELOC (home equity line of credit) is a revolving credit line with variable rates in most cases.
• Interest may be tax-deductible only when the loan proceeds are used to buy, build, or substantially improve the secured home.

How a home equity loan works

• The lender uses your home equity (appraised value minus mortgage balance) as collateral.
• Borrowing capacity is calculated using a combined loan-to-value (CLTV) ratio. Lenders commonly allow total loans up to roughly 80–90% of the home’s value, depending on credit and other factors.
• The loan is disbursed in one lump sum and repaid over a fixed term (often 5–15 years) at a fixed rate.
• If you default, the lender can foreclose on the property to recover the debt.

Home equity loan vs. HELOC

• Home equity loan: lump sum, fixed interest rate, fixed monthly payments, predictable repayment schedule.
• HELOC: revolving credit line (draw and repay repeatedly), usually variable rates, a draw period (often 5–10 years) followed by a repayment period (often 10–20 years). Some HELOCs offer fixed-rate options for portions of the balance.
• Choose a home equity loan if you know exactly how much you need and prefer payment certainty. Choose a HELOC for ongoing or uncertain expenses where flexibility matters.

Advantages

• Lower interest rates than credit cards and many unsecured loans because the loan is secured by your home.
• Predictable payments with fixed-rate loans.
• Quick access to a sizable lump sum for large expenses (home improvements, education, medical bills, or debt consolidation).
• Easier approval for many borrowers because the loan is secured.

Disadvantages and risks

• Your home is collateral—default can lead to foreclosure.
• Borrowing against your home can leave you “underwater” if property values fall.
• Using a home equity loan to consolidate debt can extend repayment terms and increase total interest paid, even if monthly payments are lower.
• “Reloading” (taking new equity loans after paying off other debts) can create a cycle of increasing debt and risk.
• Interest on portions of a loan that exceed the home’s value is not tax-deductible.

Tax treatment

Interest on a home equity loan is tax-deductible only if the loan proceeds are used to buy, build, or substantially improve the home that secures the loan. Changes in tax law and the availability of the standard deduction mean many homeowners will not benefit from itemizing interest deductions, so check current tax rules or consult a tax professional.

Typical qualification requirements

Requirements vary by lender, but common criteria include:
* Sufficient home equity—often more than 20% equity remaining after the loan.
* Verifiable income and employment history, commonly two or more years.
* Credit score typically above ~600 for conventional rates; lower scores may still qualify but at higher costs.
* Debt-to-income and appraisal outcomes also influence approval and terms.

Practical tip: estimate your equity by comparing recent local sales and your mortgage balances. Online home-value estimates can help but are not exact; consider the home’s condition and a lender’s appraisal.

How much can you borrow?

For well-qualified borrowers, lenders generally limit total loans to a CLTV of around 80–90% of appraised value. For example, on a $500,000 home with a $200,000 mortgage balance, you might be able to borrow up to about $250,000 in a second loan (subject to lender approval and CLTV rules).

Common uses and an example

Home equity loans are commonly used for:
* Home renovations that increase property value
* Consolidating higher-interest debt
* Major expenses like education or medical costs

Example: Rolling a $10,000 auto loan (9% interest, 2 years left) into a 5-year home equity loan at 4% could lower monthly payments but increase total interest paid because of the longer term—and puts your home at risk if you default. Always compare total cost, term length, and risks before consolidating.

Warnings and consumer protections

• Mortgage lending discrimination is illegal. If you suspect discrimination based on protected characteristics (race, religion, sex, marital status, public assistance, national origin, disability, or age), you can report it to federal agencies that regulate housing and consumer finance.
• Avoid borrowing more than you can reasonably repay. Excessive borrowing against home equity can lead to foreclosure and financial ruin.

Bottom line

A home equity loan can be a useful, lower-cost way to access substantial funds when you know exactly how much you need and can manage fixed monthly payments. However, because the loan is secured by your home, weigh alternatives (cash-out refinance, HELOC, personal loan) and run the numbers to ensure the loan meets your financial goals without exposing you to undue risk.