Home equity loans explained

#How a home equity loan works

A home equity loan turns part of the value you own in your home into cash. The lender pays you the full amount at closing and takes a lien on the home — usually a second lien behind your existing mortgage. You then repay it in equal monthly installments of principal and interest over a fixed term, such as 10, 15 or 20 years, while you keep paying your first mortgage as before.

The CFPB notes that a home equity loan usually has a fixed rate that won’t change. That predictability is the main difference from a HELOC, whose rate typically moves with the prime rate. The trade-off is flexibility: you borrow everything at once and pay interest on all of it from day one, and if you need more later, you need a new loan.

Common uses are one-time costs with a known price: a renovation with a fixed contract, consolidating higher-rate debts, or a large medical or education bill. Interest is tax-deductible only when the money buys, builds or substantially improves the home that secures the loan.

#What the payment looks like

A shorter term means a bigger payment but far less interest. Since the rate is fixed, the payment you sign for is the payment you keep — unlike a HELOC, where the same $50,000 would cost about $333 a month interest-only at prime plus an example 1-point margin (8%), but could rise with prime and then jump when repayment starts.

#Home equity loan vs HELOC

Pick the loan when you know the amount and value a fixed payment; pick the line when costs are uncertain or spread out. If you would replace your first mortgage anyway, compare a cash-out refinance too — cash-out refinance vs HELOC shows when that wins.

#How much you can borrow

Lenders cap the combined loan-to-value (CLTV): all loans on the home, including the new one, as a share of its appraised value. Each lender sets its own limit. On a $360,000 home with a $200,000 mortgage, an 80% limit allows up to $88,000; borrowing $50,000 would put the CLTV at 69.4%. In Texas, the state constitution caps home equity borrowing on a homestead at 80% and limits most lender fees to 2% of the loan — see the Texas guide. How much equity can you borrow? shows the math for other limits.

Your credit, income and debts matter as much as equity: federal ability-to-repay rules require the lender to make a reasonable, good-faith judgment that you can afford the payment. See home equity loan requirements.

#Costs and paperwork

Expect closing costs similar in kind to a mortgage: an appraisal or other valuation, origination or application fees, a title search and recording fees. The FTC points out that a home equity loan’s APR includes interest and other credit costs, which makes offers easier to compare.

1. 1

   Apply and get a Loan Estimate

   The lender must send it within 3 business days of your application. Compare the rate, APR, fees and cash to close across at least two or three lenders.

2. 2

   Valuation and underwriting

   The lender checks the home’s value, your credit, income and existing mortgage.

3. 3

   Review the Closing Disclosure

   It arrives at least 3 business days before closing. Check it against the Loan Estimate.

4. 4

   Close and wait out the cancellation period

   On your principal home, funds are generally released only once 3 business days have passed, so you can still change your mind.

#Your right to cancel

Federal law gives you 3 business days after closing to cancel a home equity loan on your principal home, for any reason. Saturdays count; Sundays and federal holidays don’t. Cancel in writing; the lender must return your fees and release its lien within 20 days. If you never received the required notice or key disclosures, the right can last up to 3 years. It doesn’t apply to second homes or rentals.