What Is a Home Equity Loan?
In plain English
A home equity loan is a second mortgage that allows homeowners to borrow against the equity they have built in their property, receiving funds as a lump sum repaid at a fixed interest rate over a set term. Because the loan is secured by your home, interest rates are lower than unsecured debt. However, failure to repay can result in foreclosure — your home can be lost if you default.
How Do You Calculate How Much You Can Borrow With a Home Equity Loan?
Lenders typically allow you to borrow up to 80–85% of your home's appraised value, minus what you owe on your primary mortgage. For example, if your home is worth $400,000 and you owe $250,000, your available equity is $150,000. At 85% combined loan-to-value, you could borrow up to $90,000 in a home equity loan ($400,000 × 0.85 = $340,000 − $250,000). Credit score and income also affect approval and terms.
What Are the Best Uses for a Home Equity Loan?
Home equity loans work well for large, defined expenses: home renovations that increase property value, paying for college, or consolidating high-interest debt into a lower-rate loan. Using a home equity loan for home improvements may qualify for tax-deductible interest under IRS rules. Using it for discretionary spending — vacations, luxury goods — is risky because you are putting your home on the line for non-essential expenses.
How Is a Home Equity Loan Different from a HELOC?
A home equity loan provides a lump sum at a fixed rate, with consistent monthly payments over a defined term. A HELOC (home equity line of credit) works like a credit card — you draw funds as needed during a draw period, paying variable interest only on what you use. The home equity loan is better for known, one-time expenses; the HELOC suits ongoing or variable funding needs.
Frequently asked questions
Is the interest on a home equity loan tax deductible?
Interest on a home equity loan may be tax deductible if the funds are used to buy, build, or substantially improve the home securing the loan. Interest used for debt consolidation, medical expenses, or other purposes is generally not deductible under current tax law. Consult a tax professional to confirm eligibility based on your specific situation.
Can I lose my home if I default on a home equity loan?
Yes. A home equity loan is secured by your property. If you default, the lender can foreclose. This is a critical distinction from unsecured debt like credit cards — using home equity to pay off credit cards transfers an unsecured risk to a secured risk backed by your most valuable asset.
Keep exploring
Related terms
HELOC
A HELOC (home equity line of credit) is a revolving credit line secured by your home's equity. You draw funds as needed and pay variable interest only on what you use.
Loan-to-Value Ratio
Loan-to-value ratio (LTV) compares the loan amount to the appraised value of the asset securing it. Lenders use LTV to assess risk and determine mortgage insurance requirements.
Amortization
Amortization is the process of paying off a loan through regular scheduled payments over time. Each payment covers both interest and a portion of the principal balance.
Fixed Interest Rate
A fixed interest rate stays the same for the entire life of the loan. It provides payment predictability and protects borrowers from rising market interest rates.
Debt Consolidation
Debt consolidation combines multiple debts into a single loan or payment, often at a lower interest rate. It simplifies repayment and can reduce total interest costs.
Loan Refinancing
Refinancing replaces an existing loan with a new one, ideally at a lower interest rate or better terms. It can reduce monthly payments or shorten the loan term.