Home equity loans: What they are and how they work
Quick insights
- A home equity loan (HELOAN) is a type of loan that allows you to borrow against the equity you have built in your home using your home as collateral. Home equity is calculated by subtracting the outstanding balance of any loans secured by the home from the current value of the property.
- Homeowners commonly use these loans for major expenses such as home renovations, funding education, debt consolidation and investments. Lenders usually require a substantial amount of equity in the home, stable income, good credit history and low debt-to-income ratio.
- While a home equity loan provides a lump sum with fixed interest rates, home equity lines of credit (HELOCs) offer flexible borrowing with variable rates, which could be suitable for ongoing expenses.
Are you looking to unlock the value of your home? A home equity loan, often referred to as a HELOAN, might be a good solution. This type of loan allows you to borrow against the equity you've built in your home, providing a way to access cash for big expenses like home renovations, education, debt consolidation or real estate acquisition. With typically lower interest rates than personal loans or credit cards, a home equity loan could be an attractive option for individuals looking to maximize their property investment.
Let’s dive into the process and what you may want to consider before tapping into your home’s equity.
How does a home equity loan work?
Before borrowing against your home, it might be wise to understand how these loans work. Here’s a breakdown of how to get a home equity loan:
- Calculate your home equity: Home equity is calculated based on the difference between your home’s current market value and the remaining balance on your mortgage. For example, if your home is worth $300,000 and you still owe $200,000, your home equity is $100,000.
- Determine your borrowing amount: Loan providers typically allow you to borrow up to 80% of your home’s market value, minus what you still owe on your mortgage. Using the example above, 80% of $300,000 is $240,000. After subtracting your remaining mortgage balance of $200,000, you could potentially borrow $40,000. Your actual borrowing limit may vary based on factors such as your credit score, income and debt-to-income ratio.
- Apply for a home equity loan: To get a home equity loan, first compare rates, terms and fees from different lenders. Loan providers will evaluate various factors, including, but not limited to, your financial situation, credit history and home’s value. This may involve a home appraisal.
- Close on your loan and pay associated fees: Similar to a conventional mortgage, a home equity loan may come with closing costs, which could include appraisal fees, title insurance and origination fees. These costs can be significant and play an important role in considering whether a HELOAN is right for you.
- Draw funds in a lump-sum payment: Unlike a HELOC, which offers flexible borrowing, a home equity loan provides an upfront lump-sum payment if approved.
- Repayment based on loan terms: Most home equity loans have fixed interest rates, meaning your monthly payments remain the same over the life of the loan. Typical repayment terms range from 5 to 30 years. A longer term results in lower monthly payments but higher total interest costs. Your payments will include both principal and interest.
- Use the funds wisely: Many homeowners use the funds for home improvements, debt consolidation, investment opportunities or emergency expenses. How best to use the funds will depend on your individual circumstances.
Requirements to get a home equity loan
HELOAN, like other financing options, comes with certain requirements. Lenders will typically look for:
- Adequate home equity: Lenders typically prefer homeowners who have built up a significant amount of equity in their home already. Lower equity means less to borrow against, too.
- Stable income: As with any loan, lenders want to see consistent income that suggests you’ll be able to repay the loan.
- Good credit history: While not always mandatory, a good credit history can be beneficial.
- Low debt-to-income (DTI) ratio: A lower debt load compared to your income indicates to lenders you could effectively handle new debt.
Pros and cons of a home equity loan
Home equity loans, like other financial products, come with their own set of potential advantages and disadvantages. Let’s look at some of these to help you make a more informed decision:
Advantages of a home equity loan
- Fixed interest rates: Home equity loans typically come with fixed interest rates, meaning consistent monthly payments throughout the loan term.
- Flexible use: The funds from a home equity loan can generally be used for various purposes.
- Lump-sum disbursement: Homeowners generally receive the loan amount all at once.
Home equity loan disadvantages
- Your home is collateral: Since the loan is secured by the home itself, there’s the potential risk of foreclosure if the loan isn’t repaid as agreed.
- Additional debt: Taking out a home equity loan means more debt, requiring additional financial management.
- Closing costs: As with an initial mortgage, a home equity loan may come with closing costs and other fees.
- Reduced equity: Borrowing against it reduces the total amount of equity you have in your home.
Alternatives to home equity loans
While home equity loans are typically a popular option for accessing the equity in your home, there are alternative financing methods to consider:
- Cash-out refinancing: Replaces your existing mortgage with a new one for a higher loan amount. It allows you to access the difference in cash. This option may offer lower interest rates than home equity loans. It combines the first mortgage and cash-out portion into a single loan.
- HELOC: Allows you to borrow against your home’s equity as needed using your home as collateral. This option typically offers variable interest rates and provides flexibility to draw funds over time for various expenses.
In summary
A home equity loan lets you borrow against the equity you’ve built in your home, possibly with more favorable terms than an unsecured personal loan or credit card. It’s important, however, to keep in mind that you are borrowing against the equity you’ve built in your home using it as collateral. Accordingly, failure to repay your home equity loan may have implications for your homeownership, including possible foreclosure.
While Chase does not offer home equity loans, we do provide other ways to tap into your home’s equity, including cash-out refinancing and home equity lines of credit (HELOCs). Learn more about your options here or speak with a qualified home lending professional to learn more about how HELOCs and cash-out refi might be valuable to you.
Home equity loan FAQs
1. Is a home equity loan a second mortgage?
Yes, a home equity loan is sometimes referred to as a second mortgage. This is because it allows homeowners to borrow against the equity in their homes, similar to how a primary mortgage functions.
2. Are home equity loans a good idea?
Whether a home equity loan is a good idea largely depends on your personal goals and unique financial circumstances. A home equity loan can potentially offer a lower interest rate compared to other types of loans and can be used for various purposes. However, since your home serves as collateral, there’s additional risks to consider if you were to default on the loan.
3. Do you need an appraisal for a home equity loan?
Yes, most lenders require a home appraisal for a home equity loan to determine the current market value of your home. This helps them measure the amount of equity you have—one of the key factors in the loan amount you might qualify for. The appraisal is a standard requirement to ensure the loan amount is justified by the home's value, which protects both the lender and the borrower.
