What Is a Home Equity Loan? How to Borrow Against Your Home

What Is a Home Equity Loan?

A home equity loan is a type of loan that allows homeowners to borrow money using the equity in their home as collateral. Equity is the difference between your home's current market value and the amount you still owe on your mortgage. If your home is worth $400,000 and you owe $250,000, you have $150,000 in equity.

Home equity loans are sometimes called second mortgages because they are a second lien on your property, subordinate to your primary mortgage. They allow homeowners to access large sums of money at relatively low interest rates — but the risk is real: failing to repay can result in losing your home.

How Home Equity Loans Work

With a home equity loan, you receive a lump sum of money upfront and repay it over a fixed term — typically 5 to 30 years — at a fixed interest rate. Monthly payments remain constant throughout the loan term, making budgeting predictable.

Lenders typically allow you to borrow up to 80–85% of your combined loan-to-value (CLTV) ratio. Combined LTV is calculated as:

(Existing mortgage balance + new loan amount) ÷ Home value

Example: Home worth $400,000, existing mortgage of $250,000. At 80% CLTV, you could borrow up to $70,000 ($400,000 × 80% = $320,000 − $250,000 = $70,000).

Home Equity Loan vs. HELOC

A Home Equity Line of Credit (HELOC) is often confused with a home equity loan, but they function differently:

• Home equity loan: Lump sum, fixed rate, predictable monthly payments.
• HELOC: Revolving credit line, variable rate, borrow as needed up to your limit during the draw period (typically 10 years), then repay during the repayment period.

A HELOC works more like a credit card backed by your home. It offers flexibility but introduces interest rate risk, since most HELOCs have variable rates tied to the prime rate.

Common Uses for Home Equity Loans

• Home improvements: Renovations that increase property value — kitchens, bathrooms, additions.
• Debt consolidation: Paying off high-interest credit card debt with lower-rate home equity financing.
• Education expenses: Funding college tuition when other options are exhausted.
• Major purchases: Medical bills, emergency expenses, or large one-time costs.

Tax Deductibility

Under current IRS rules, interest on a home equity loan or HELOC is tax-deductible only if the funds are used to buy, build, or substantially improve the home that secures the loan. Interest on funds used for personal expenses — like paying off credit cards — is no longer deductible after the 2017 Tax Cuts and Jobs Act.

Qualification Requirements

To qualify for a home equity loan, lenders typically look for:

• At least 15–20% equity in your home.
• A credit score of 620 or higher (better rates require 700+).
• A debt-to-income (DTI) ratio below 43%.
• Proof of stable income and employment.

Risks and Considerations

The most serious risk of a home equity loan is foreclosure. Because your home serves as collateral, the lender can foreclose if you default on payments. This makes home equity borrowing fundamentally different from unsecured debt.

Other risks include:

• If home values decline, you could owe more than your home is worth (being underwater).
• Closing costs (typically 2–5% of the loan amount) reduce the effective value of borrowing.
• It increases your overall mortgage debt burden.

Is a Home Equity Loan Right for You?

A home equity loan can be an excellent financial tool when used for value-adding purposes like home improvements, or to consolidate debt at a significantly lower interest rate. It becomes risky when used to fund consumption, vacations, or speculative investments.

Before borrowing against your home, consider whether you have stable income to make consistent payments, whether you plan to stay in your home long enough to benefit, and whether there are lower-risk alternatives such as personal loans or savings.