What Is a Home Equity Loan, and How Does It Work?

A home equity loan allows you to borrow a lump sum against the equity you’ve built in your home—the difference between its market value and what you still owe. With fixed payments and a predictable interest rate, it’s a reliable option for funding big expenses like home improvements or debt consolidation.

In this guide, we’ll walk you through every step of the process—from a deeper look at what a home equity loan is to applying for a loan to paying it off, so you can make the most of your home’s value.

What is a home equity loan?

A home equity loan provides borrowers with a lump sum, using their home as collateral. It comes with a fixed interest rate and predictable monthly payments, making it easier to budget for repayment. However, since your home secures the loan, missing payments could result in foreclosure, so it’s important to borrow responsibly.

Your available equity—the amount you can borrow—is calculated by subtracting what you owe on your mortgage from your home’s current market value. Lenders typically allow you to borrow up to 80-90% of this equity, depending on your creditworthiness and financial situation.

While home equity loans and home equity lines of credit (HELOCs) both leverage home equity, they work differently. A home equity loan gives you a one-time payout with structured repayment, while a HELOC provides a revolving line of credit you can access as needed.

Many borrowers choose home equity loans for large, one-time expenses like home renovations or debt consolidation because of their stability. The fixed rate and payments offer predictability, making it easier to manage long-term financial commitments.

How does a home equity loan work?

When you take out a home equity loan, you’ll get a one-time cash disbursement, then repay that cash over a set timeframe. You can almost think of home equity loans as high-dollar, home-secured personal loans.

With home equity loans, how much you can borrow depends on three figures:

1. Your home’s appraised value
2. Your remaining mortgage balance
3. Your loan-to-value ratio (LTV)

Lenders use your home value and mortgage balance to determine your home equity. Say, for example, that your home appraises for $300,000. If you owe $195,000 on your existing mortgage, you’ll have $105,000 in home equity.

Step three adds in your LTV amount continuing with the example below: 

Your LTV compares your home value to your mortgage balance. It helps lenders understand how much you owe on your home relative to what it’s worth. Most lenders only allow LTVs up to 85%. 

In this case, an 85% LTV threshold means you have the potential to borrow $255,000 in home-related financing (85% x $300,000 = $255,000). In this example, you have $105,000 in equity, but your home equity loan can’t exceed $60,000 since the LTV calculation incorporates the mortgage balance.

By imposing LTV limits, your lender protects itself if your property value tanks or you default on the loan. These limits also protect you from borrowing more than you can afford to repay.

Speaking of repayment, you’ll typically make your first payment within a month or two of your loan disbursement. Most lenders offer repayment terms between five and 30 years, so you can choose the loan length that best fits your finances.

Along those lines, home equity loans almost always come with fixed rates. Because your interest rate never changes, your monthly payment won’t either. Those stable, predictable payments translate to easier budgeting and a more manageable repayment.

How do you qualify for a home equity loan?

Home equity loan eligibility hinges primarily on your creditworthiness, your debt-to-income ratio (DTI), and how much equity you have. Specific home equity loan requirements vary from one lender to the next, but in general, this is what lenders hope to see:

Factor	Threshold
Credit score	620 or higher
DTI	43% or less
Equity	20% or more

If you’re right on the cusp of qualifying, consider applying after you’ve worked on your credit. Besides, each of these factors complements the other. Gains you make in one area will lead to gains in another—and potentially better approval odds, lower rates, and higher loan limits. 

Say you want to reduce your credit card balances before applying for a home equity loan. As those balances come down, your credit score should go up. Your DTI—which compares your monthly debt payments to your monthly income—will improve, as well.

At the same time, you’ll get a few more mortgage payments under your belt. This frees up more of your equity. Not only will you be a stronger home equity loan applicant, but you may also get approved for a better loan overall.

How to get a home equity loan

Getting a home equity loan follows a similar process as other types of loans. Here’s what you’ll do:

1. Narrow down your list of lenders. We recommend starting with at least four potential matches. We’ve researched the best home equity loans to help you make your selections.
2. Prequalify. When you prequalify, you’ll get personalized, preliminary rates—with no hard credit inquiry. It’s a no-risk way to see what each lender can offer.
3. Choose a lender. Evaluate the home equity loans you qualify for. Compare APRs, terms, and fees. Once you’ve decided on the best-fit loan, head to the next step.
4. Fill out an application. At this point, you’ll submit your proof of income and property ownership. You’ll also consent to a hard credit pull. 
5. Schedule the appraisal. If you’re approved, your lender will work with you to coordinate an in-person appraisal. Some lenders, like Figure, may conduct virtual appraisals. No matter the method, this is a necessary step in securing a home equity loan.
6. Sign your loan agreement. After the appraisal, your lender can finalize your loan offer. Review the offer carefully, and sign on the dotted line to accept your home equity loan.

From prequalification to funding, closing on your home equity loan can take anywhere from a couple of weeks to a couple of months. 

To speed up the process, make digital copies of these documents ahead of time: 

• W2s, paystubs, or tax returns
• Proof of homeowners insurance
• Proof of flood insurance, if applicable
• Most recent property tax statement
• Most recent mortgage statement

Keep an eye out for any communications from your lender, too. The sooner you respond, the sooner you could get your loan.

Read More

How Long Does It Take to Get a Home Equity Loan?

How do you repay a home equity loan?

Paying back home equity loans is similar to paying back auto loans or personal loans. To repay your home equity loan, you’ll make fixed monthly payments through the end of your loan term.

Your rate determines what you pay each month. It also determines your interest expense, or how much you pay your lender for letting you borrow money.

To better illustrate how your rate impacts you, pretend you and a friend both get $75,000 home equity loans with 20-year terms. Thanks to credit improvements and careful rate shopping, you snag a lower rate than your friend. Here’s what each of you will pay for the same $75,000:

Compared to your friend, you’re paying roughly $20,000 less over the life of your loan. Your monthly payments are nearly $100 less to boot.

The more manageable your payments, the less likely you are to default on your loan. If you miss payments, you could end up with negative marks on your credit report. Because your payment history makes up a third of your score, late payments can wreak havoc on your credit.

Remember, too, that your house is on the line. Too many missed payments could result in your lender foreclosing on your home.

How long are home equity loan terms?

Home equity loans usually come with terms between five and 30 years, giving borrowers flexibility to choose what best fits their needs. While shorter terms can save you on interest, longer terms provide lower monthly payments that might be easier to manage, especially if you’re juggling other financial commitments.

Here are the typical term length ranges and what they mean for you:

• Five to 10 years: If you’re comfortable with a higher monthly payment, a shorter term can reduce the interest you pay overall. This option is popular for borrowers who want to pay down their loan quickly and save on interest costs.
• 15 to 20 years: These terms offer a balance between affordability and interest savings. Monthly payments are generally manageable, and you won’t be tied to the loan for as long as a 30-year term.
• 30 years: If you’re focused on keeping monthly payments as low as possible, a longer term may be the way to go. Just be aware that this convenience comes with higher interest costs over time, as you’ll be paying it off for many years.

To give you a sense of what these terms might look like, consider a $50,000 loan with a fixed 6% interest rate. Over a 5-year term, monthly payments would be around $966. A 30-year term would bring them down to about $300. However, with the 30-year term, you’d end up paying more in interest over the life of the loan.

Term (years)	Monthly payment	Total interest paid
5	$966.64	$7,998.40
10	$555.10	$16,612.30
20	$358.22	$35,971.73
30	$299.78	$57,919.09

When choosing a term, it’s all about finding the sweet spot for your monthly budget and long-term goals. A shorter term can help you save on interest, while a longer term can offer more breathing room in your monthly budget.

Here’s a quick look at some popular lenders and their term options:

Lender	Repayment terms (years)
Spring EQ	5 – 30
Navy Federal Credit Union	5, 10, 15, or 20
Discover	10, 15, 20, or 30
Prosper	5 – 30

How to use a home equity loan

You can spend your home equity loan funds on whatever you wish. Still, some purposes are wiser than others. In our humble opinion, these are the smartest ways to use a home equity loan:

• Debt consolidation
• Home improvements
• Medical expenses
• Tuition

In short, it’s best to put your loan toward expenses that benefit you in the long run. 

Along those lines, you could use your home equity loan for an investment property. Make sure you do your research, though. This strategy might not make sense if your new property needs extensive repairs or won’t generate a positive cash flow relatively quickly.

To that end, we don’t recommend using your home equity loan to cover risky or unnecessary expenses like these:

• Playing the stock market or padding your 401(k)
• Starting a business
• Lavish weddings or vacations

A good rule of thumb is not to use your home equity loan in ways that could drive you deeper into debt. Instead, channel your home equity loan toward purchases that have a lasting positive impact on your financial health and personal well-being.

Another reason to take out a home equity loan is if you are pursuing a business venture or other investment that has a solid foundation, although you will want to understand and be able to absorb the risks that could be associated with that. For example, if the business/investment does not yield what was expected or fails, you must ensure you can still pay the monthly payments.

To remain low-risk, I recommend using the home equity loan to improve your home or consolidating high-interest debt into a lower rate/lower monthly payment.

Erin Kinkade, CFP®

Pros and cons

Pros

• Often have lower rates

  Home equity loans tend to have better rates than personal loans and credit cards. Those lower rates often translate to interest savings and more affordable payments.

• No usage restrictions

  As long as you’re not doing anything illegal, you can use your home equity loan however you please. Pay down debt, go back to school, upgrade your HVAC—or all of the above.

• Higher loan amounts

  Home equity loans usually give you tens of thousands of dollars upfront. That hefty sum lets you cover larger expenses or meet multiple financial goals with just one loan.

• Possible tax benefit

  Few financing products come with the potential for tax savings—but home equity loans do. Depending on when you open your loan, you could deduct the interest on your taxes.

• Consistent payments

  Variable rates and balances result in fluctuating monthly payments, but this isn’t a concern with home equity loans. You’ll have the same payment month after month with no changes or surprises.

Cons

• Harder to qualify

  A solid credit score alone isn’t enough to get a home equity loan. Additional eligibility requirements, like having at least 20% equity, can make these loans less accessible.

• Might come with fees and closing costs

  Home equity loans may come with comparatively low rates, but that doesn’t automatically mean they’re more economical. Origination fees and closing costs can sometimes drive up the price, making these loans more expensive than anticipated.

• Could lose your home

  The risk of foreclosure is arguably the biggest downside of home-secured financing. If your loan payments become too much for too long, your lender could seize your home.

Several reasons/examples you may want to avoid taking out a home equity loan is if you:

Are already struggling to make the regular mortgage monthly payments (i.e. you have pared down all expenses with a little room for discretionary) since this could lead to a higher probability of foreclosure.

You are concerned about housing market fluctuations, have unstable income and/or future career instability, or if you are nearing the end of your mortgage term and you do not want to add another long-term debt. 

Erin Kinkade, CFP®

Is getting a home equity loan a good idea?

Home equity loans may be the right choice if you’re financially stable, have sufficient equity, and will use the funds responsibly. The table below will help you get a better sense of when home equity loans are a good idea.

If you …	Consider a home equity loan?
Live in an area with rising property values	Yes
Need ongoing access to cash	No
Can qualify for a low rate	Maybe
Can handle an additional debt payment	Yes
Need to borrow a small amount	No
Don’t need immediate funding	Maybe

You’ll notice that there’s not always a cut-and-dry answer to the home equity loan question. In some cases, it’s clear whether a home equity loan is the best move. In others, it may be harder to decide.

After all, there are many ways to take equity out of your home. Before committing to any one financing tool, it’s worth weighing your options.

Tip

Home equity investments let you tap your equity with no monthly payments. How do they work? You’ll sell a portion of your equity in exchange for cash, then buy it back at a later date.

To decide if a home equity loan is the right choice for you, I suggest making a list and assessing the following:

• Your financial condition: i.e. credit score, debt-to-income ratio, and stability of income)
• Why you are seeking a home equity loan or HELOC? What is the purpose and is it reasonably beneficial and low risk of losing your home?
• The costs vs. the benefits to ensure the benefits outweigh the costs: both of your money and time
• Whether you can repay the new loan without cutting your cash-flow too tight
• Alternatives, if needed

Engage with a financial professional and mortgage specialist to further guide you.

Erin Kinkade, CFP®

Home equity loan alternatives

If you’re exploring ways to tap into your home’s equity or need financing options, a home equity loan isn’t your only choice. Below are some alternatives to consider, depending on your needs and financial situation.

HELOC

	Home equity loan	HELOC
Collateral	Yes (home)	Yes (home)
Interest rate	Fixed	Variable (some lenders offer fixed options for part of the balance)
Payment structure	Fixed monthly payments	Interest-only payments during the draw period, then full payments
Loan amount	Large lump sum, based on available home equity	Flexible borrowing during the draw period
Repayment period	5-30 years	Draw period (usually 5-10 years) followed by repayment period
Risk	Risk of foreclosure if you default	Risk of foreclosure if you default
Best for	Large, one-time expenses	Ongoing or flexible expenses, such as home improvements

A HELOC is another way to leverage your home equity, but unlike a home equity loan, it functions more like a credit card. Instead of receiving a lump sum, you get access to a revolving credit line that you can borrow from as needed during the draw period.

You can borrow and repay multiple times within a set draw period, typically 5-10 years. After the draw period ends, you enter the repayment phase, where you make principal and interest payments on the balance owed.

Best for:

• Borrowers who need flexibility and want to withdraw money over time rather than all at once.
• Homeowners planning ongoing expenses, like a series of home renovations.
• Those who prefer to only pay interest on the amount they’ve borrowed.

Cash-out refinance

	Home equity loan	Cash-out refinance
Collateral	Yes (home)	Yes (home)
Interest rate	Fixed	Fixed
Payment structure	Fixed monthly payments	Fixed monthly payments based on a new mortgage
Loan amount	Based on home equity	Can be larger if your home has appreciated significantly
Repayment period	5-30 years	Based on the new mortgage term (15-30 years typically)
Risk	Risk of foreclosure if you default	Risk of foreclosure if you default
Best for	Borrowers needing a lump sum for major expenses	Those who want to refinance their mortgage and access home equity

A cash-out refinance allows you to replace your existing mortgage with a new one for a higher amount. The difference between your old mortgage balance and the new loan is paid in cash, which you can use however you’d like.

You refinance your home for more than you owe, pocketing the difference. This can be a good option if interest rates are low and you’re ready to commit to a new mortgage term.

Best for:

• Borrowers looking to consolidate their mortgage and a new loan into one payment.
• Homeowners who want to take advantage of lower interest rates and need access to a larger sum of cash.
• Those with significant home equity who want a long-term financing solution.

Personal loan

	Home equity loan	Personal loan
Collateral	Yes (home)	No, unsecured
Interest rate	Fixed	Fixed (but typically higher than home equity loans)
Payment structure	Fixed monthly payments	Fixed monthly payments
Loan amount	Large sums, based on home equity	Smaller amounts, often less than home equity loans
Repayment period	5-30 years	1-7 years
Risk	Risk of foreclosure if you default	No risk to your home
Best for	Borrowers with significant home equity needing a large sum	Borrowers needing quick, smaller, unsecured funds

A personal loan is unsecured, meaning it doesn’t require any collateral like your home. It’s typically a quicker option with less paperwork than home equity loans or refinances.

You receive a lump sum upfront and repay the loan in fixed monthly installments over a set period, usually one to seven years. Since it’s unsecured, interest rates may be higher than for loans backed by home equity.

Best for:

• Borrowers who don’t have enough home equity or prefer not to use their home as collateral.
• Those who need faster access to funds for smaller expenses or debt consolidation.
• Homeowners who want fixed monthly payments but with a shorter loan term.

FAQ 

What is the minimum credit score for a home equity loan?

The minimum credit score for a home equity loan typically falls around 620, but this can vary by lender. Some lenders may have stricter requirements, especially if you’re borrowing a significant portion of your home’s equity. A higher credit score generally helps you qualify for better interest rates and loan terms.

Can you get a home equity loan with bad credit?

While it’s more challenging to get a home equity loan with bad credit, it’s still possible. Some lenders offer loans to borrowers with lower credit scores but expect higher interest rates and stricter terms. The amount of equity in your home and your debt-to-income ratio will also be important factors in the approval process.

What is home equity?

Home equity is the portion of your home that you own, calculated by the difference between your home’s current market value and any outstanding mortgage or loan balances. It grows as you pay down your mortgage or as your property’s value increases over time.

How is home equity calculated?

Home equity is calculated by subtracting your outstanding mortgage balance from your home’s market value. For example, if your home is worth $300,000 and you owe $150,000 on your mortgage, your home equity is $150,000. This equity can be used as collateral when applying for a home equity loan or HELOC.

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