What Is a Home Equity Loan?

Surprise expenses or the desire to remodel your home could be budget busters. But if you’ve invested in a house that’s gained value over time — or you’ve paid your mortgage balance down below what the home is worth — a home equity loan might be the financial tool you’re looking for. Find out more about home equity loans and how you might use them below.

What Is a Home Equity Loan?

A home equity loan is debt you secure with equity in your home. It’s also called a second mortgage.

How Does a Home Equity Loan Work?

When you take out a home equity loan, you borrow against the value of your home that’s not already secured by a mortgage.

For example, consider a home that’s worth $200,000. If the current mortgage balance on the home is $80,000, the homeowner has $120,000 in equity. You can figure out how much equity you have by subtracting your mortgage balance from the current value of your home.

Depending on credit history, income and other factors, the homeowner in the example could borrow up to $120,000 as a home equity loan. Not all lenders will allow you to leverage the total value of the home, though. Many set a percentage of the total value that can be used in the home equity loan calculation.

For example, if a lender sets the percent at 80 percent of your home’s value, that would be $160,000 (on a home worth $200,000). If the homeowner owed $80,000, they could borrow $80,000.

It’s important to realize that closing costs and other factors related to traditional mortgages may also apply.

Who Can Get Approved for a Home Equity Loan?

Whether you can get a home equity loan depends on a variety of factors. They may vary slightly by lender but include:

  • How much equity you have in your home.
  • What your credit history and score are.
  • How much income you bring in.
  • What your current debt load is.

In short, lenders do need to ensure you have the means to pay back your home equity loan, and they may also look for evidence that you historically pay your debts on time. While underwriting for a home equity loan may not be as intense as the original process for getting a mortgage, be prepared to submit documents demonstrating your income, assets and expenses if asked.

What Can You Use a Home Equity Loan for?

You can use the funds from your home equity loan for a variety of purposes. In most cases, the use of the funds is at your discretion as long as it’s within legal means. Some popular uses for home equity loans include:

  • Investing in improvements on the home. Adding a new room, upgrading appliances, updating countertops or turning a half bath into a full are some examples. Many homeowners use home equity loans for these purposes based on the belief that the improvements will increase the value of the home and allow them to get a better sales price in the future.
  • Covering an unplanned expense. A sudden medical crisis that results in a large bill or other urgent issues can lead people to consider home equity loans.
  • Debt consolidation. Some people use funding from home equity to pay off existing bills. This could help those with high-interest credit card debt save money in the long run, for example, but the Consumer Financial Protection Bureau notes that homeowners should run all the numbers to ensure that’s the case. It’s also important to be careful not to run up balances on paid-off credit cards or other accounts, or you could end up with double the debt you started with.
  • Making a big purchase. In some cases, a home equity loan might make more sense financially than other forms of debt. People use the funds to purchase large-ticket items such as vehicles, boats, RVs or jewelry.
  • Covering college tuition. If you have enough equity in your home, it might be possible to cover most or all of your or your child’s college tuition. You would obviously want to compare interest rates for the loan to options for student loans, though. Those that can qualify for student loans can also get deferrals and other assistance that aren’t typically available with home equity loans, so consider all the factors before making your decision.

What Are the Benefits of Home Equity Loans?

Because these loans are secured by the value of your home, they may come at a lower interest rate than other forms of debt. That can make them preferable for homeowners over personal loans or credit cards.

You may also be able to claim the interest you pay on home equity loans as a deduction on your income tax return. That could result in a slightly smaller tax burden at the end of each year.

What Are Some Potential Disadvantages of Home Equity Loans?

The one major disadvantage to a home equity loan is that it’s secured by your house. If anything happens and you can’t pay the loan, the lender may be able to force the sale of your home to recoup its losses. As with any debt, you should always ensure you have the ability to make your payments before you sign on the dotted line.

If you borrow a maximum amount via a second mortgage and the value of your home decreases in the future, you could end up owing more total on your home than it’s worth. That can be a challenge if you plan on selling your home. Consider why you need a home equity loan carefully and if it’s worth these risks.

What’s the Difference Between a Home Equity Loan and a HELOC?

A HELOC is a home equity line of credit. It works the same as a loan but you get a specific line of credit instead of receiving all the funds at once. You can use the line of credit like you would a credit card, making purchases with it and paying it back before reusing it.

What’s the Difference Between a Home Equity Loan and a Cash-Out Refi?

When you refinance, you take out a whole new mortgage. The funds you receive are used, all or in part, to pay off your existing mortgage. If you have equity in your home and borrow over what you owe on it, you can get the difference back in cash. This is called a cash-out refinance.

You can use the funds from a cash-out refi in all the ways you could use funds from a home equity loan. The major difference is that with a cash-out refi, you only end up with one loan tied to your house.

How Can LemonBrew Lending Help?

We know the mortgage process itself can be complex and confusing, and when you start adding second mortgage or refinance options, things might seem intimidating. With LemonBrew Lending, you can trust in guidance from professionals that care about your experience and work to ensure positive outcomes. Whether you’re ready to start the lending process for a first home purchase or want to refinance the mortgage on your third home, LemonBrew Lending has you covered.

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