How Do Home Equity Loans Work?

Your home is a valuable asset, and one that you can tap into in times of need. A home equity loan can be a way to cover expenses like home improvements, and even things like college tuition and high-interest credit card debt. Here’s how it works.

What is home equity?

This is an easy one. Home equity is the difference between the current value of your property and what you still owe on an existing mortgage. For example, if your property is worth $300,000, and you still owe $100,000, you have $200,000 in equity.

Nationally, home equity has been near record highs as home prices have risen. The St. Louis Federal Reserve found that homeowners had over $31 trillion in home equity in the second quarter of 2023. This compared to a record high of over $32 trillion in Q2 2022.

What’s a home equity loan?

A home equity loan (HEL) is a way to borrow money using the equity in your home as the collateral. It creates a second mortgage against your home for the amount of equity you want to turn into cash.

That means they leave you current mortgage in place, which is appealing to some homeowners in today’s market. Most have mortgages with interest rates around 3 to 4%, but 30-year fixed rates have reached between 7 to 8% in 2023.

How much can you borrow with a home equity loan?

The amount you can borrow is usually limited to 80% or 85% of your home equity. The final amount is subject to other factors like your income and credit history, as well as the market value of your home.

Borrowers receive the money as a lump sum, and the loan will usually have a fixed interest rate. That said, interest rates for HELs tend to be higher than traditional 30-year fixed-rate mortgages, because home equity loans involve more risk for lenders.

Are home equity loans different than a home equity line of credit?

Yes. A home equity line of credit, or HELOC, is another way to borrow using the equity in your home as collateral. However, with a HELOC, homeowners have the ability to borrow multiple times from the maximum amount available, and interest rates are usually adjustable.

Homeowners can typically borrow up to 85 percent of the home’s appraised value, less the amount owed on the mortgage. Additionally, a HELOC is a revolving line of credit—not a single payout. It works much like a credit card.

As the Consumer Financial Protection Bureau (CFPB) notes, HELOCs also typically have adjustable interest rates. Adjustable rates can be less predictable and carry the risk that the interest rate may go up.

How is a home equity loan different from a cash-out refinance?

While a home equity loan is a second mortgage, a cash-out refinance would replace your existing mortgage with a new mortgage that includes the amount you want to cash out. So, if you have a $200,000 balance on your home loan, and want to take out $50,000 in equity, a cash-out refinance would create a new mortgage for $250,000.

With a home equity loan, only the $50,000 in equity would be subject to today’s higher rates. But with a cash-out refinance, the entire $250,000 balance would be. That said, a cash-out refinance can still make sense for some homeowners, especially if they have a lower mortgage balance. A Mortgage Professional can help you understand your options.

Can home equity loans be used to consolidate debt?

Yes, the funds from a home equity loan can be used on whatever you like, including paying down debt. High-interest debt, like credit card debt, is top of mind for many Americans, with credit card balances reaching over $1 trillion. But a home equity loan can provide the cash to pay it off for less.

According to an Investopedia database, the median interest rate of credit cards tracked was over 24% as of Nov. 1, 2023. As noted above, mortgage rates are much lower—with 30 year fixed-rates around 7 to 8%.

Want to learn more about your home equity loan options?* Call us at 833-685-2565 or get started online.

* Second mortgages available for primary residences only. Second mortgage/home equity loan amounts depend on the amount of equity you have in your home, your credit score, debt-to-income ratio, and other factors and program limits on the combined loan-to-value ratio. Not all borrowers or properties will qualify.