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How a Home Equity Loan Works

If the value of your home is greater than what you owe on the mortgage, you may be able to borrow money using the home as collateral.
Oct. 3, 2018
Finding the Right Mortgage, Mortgages
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We adhere to strict standards of editorial integrity. Some of the products we feature are from our partners. Here’s how we make money.

It could be a pile of cash you didn’t know you had — the value built into your home. You can access a portion of that appreciation with a home equity loan, using your property as collateral.

To qualify for a home equity loan, you first need home equity. You have equity when your home’s value is higher than what you owe on the mortgage.

And the more equity you have, the more you should be able to borrow.

How much money can you get from a home equity loan?

A home equity loan generally allows you to borrow around 80% to 85% of your home’s value, minus what you owe on your mortgage.

Here’s how to get a rough estimate of the amount you may be able to borrow (or just let our home equity calculator do the math for you):

Let’s say your home is worth $350,000, your mortgage balance is $200,000 and your lender will allow you to borrow up to 80% of your home’s value.

$350,000 x 80% = $280,000

$280,000 – $200,000 = $80,000 (possible loan amount)

» MORE: 5 good reasons to tap your home equity

How you get your money with a home equity loan

A home equity loan gives you money all at once. If you know how much money you’ll need and when you’ll need it — for a remodeling project with a fixed budget, for example — it may be the right choice.

This home equity loan, which is a second mortgage, is structured much like your purchase mortgage: You’ll repay this loan — principal and interest each month — at a fixed rate over a set number of years.

You can get a fixed interest rate and know that, at the end, you’re going to have a zero balance.

Carlos Miramontez, vice president of mortgage lending at Orange County's Credit Union

“You can get a fixed interest rate and know that, at the end, you’re going to have a zero balance,” says Carlos Miramontez, vice president of mortgage lending at Orange County’s Credit Union in California.

With a home equity loan, you could encounter a minimum loan requirement, which typically ranges from $10,000 to $25,000, according to Miramontez.

» MORE: A home equity loan is a smart choice as rates rise

Home equity loan pros:

  • Fixed rates provide predictable payments, which makes budgeting easier.
  • Lower interest rates than a personal loan or credit card.
  • Quicker close times than for a cash-out refinance.
  • If your current mortgage rate is low, you don’t have to give that up.

Home equity loan cons:

  • Less flexibility than a home equity line of credit (HELOC).
  • You’ll pay interest on the entire loan amount, even if you’re using it incrementally, such as for an ongoing remodeling project.
  • More lenders are offering HELOCs than home equity lump sum loans.

Typical requirements:

  • Home equity of at least 15% to 20%, usually confirmed by an appraisal.
  • A credit score of 620 or higher.
  • Debt-to-income ratio of 43%, or possibly up to 50% (calculate your DTI).

For a deeper dive into what it takes to qualify, see NerdWallet’s home equity loan requirements guide.

» MORE: The best home equity loan lenders of 2018

Alternatives to home equity loans

HELOC

Unlike the home equity lump sum loan, a HELOC provides flexibility by letting you borrow what you need, pay it off and borrow again; it’s similar to using a credit card. In fact, a HELOC often comes with a credit or debit card, or a book of checks.

The other main difference is that HELOCs have variable interest rates, which means your rate could rise or fall over the life of the loan, making your payments less predictable. In general, the rate on a HELOC will be discounted in the beginning. But after an introductory phase of around six to 12 months, the interest rate goes up.

» MORE: Home equity loan vs. HELOC: pros and cons

cash-out refinance

Another way to tap your home equity is a cash-out refinance. Unlike the home equity lump sum loan and HELOC, which are second mortgages (on top of your first), a cash-out refi replaces your existing mortgage with one that totals more than you owe on your home.

The “more than you owe” portion is the money you “cash out” and spend on what you need. By comparison, a traditional refi replaces your existing mortgage with a new one for the same loan balance.

» MORE: How to use a cash-out refinance

Cash-out refinancing can make sense if the interest rate offered is lower than the rate on your existing mortgage. But if your mortgage already has a low rate and refinancing results in a loan with a higher rate, a better option may be a home equity loan or HELOC.

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