Equity is your home's market value minus your mortgage balance. Although it's sometimes called a second mortgage, a home equity loan doesn't affect your mortgage. Your mortgage interest rate, term and payments stay the same—you'll just have another monthly payment.
When you take out a home equity loan, the lender approves you for a loan amount based on the percentage of equity you have in your home and other factors. You'll receive the loan proceeds in a lump sum, then repay what you borrowed in fixed monthly installments that include principal and interest over a set period.
With a home equity loan, you apply for the amount you need. Most charge a fixed interest rate that doesn't change during the life of the loan.
Deciding To Take Equity Out Of Your Home
Whether you choose a home equity line of credit (HELOC), a home equity loan, or a sale-leaseback agreement, you can unlock your home's equity while avoiding refinancing. This also applies to investment properties, too.
A mortgage equity withdrawal (MEW) is the removal of equity from the value of a home through the use of a loan against the market value of the property. A mortgage equity withdrawal reduces the real value of a property by the number of new liabilities against it.
HELOCs are generally the cheapest type of loan because you pay interest only on what you actually borrow. There are also no closing costs. You just have to be sure that you can repay the entire balance by the time that the repayment period expires.
You get the money in a lump sum, and then you make regular monthly payments for a set period of time until you've paid it back. The loan is secured by your home, so the lender has a legal claim on the property in case you don't pay off the loan as agreed. Home equity loans usually have fixed interest rates.
The maximum amount a lender will offer you is typically 80% to 85% of your combined loan-to-value (CLTV) ratio, a measure of the difference between the value of your house and how much you are borrowing.
Loan payment example: on a $50,000 loan for 120 months at 8.40% interest rate, monthly payments would be $617.26. Payment example does not include amounts for taxes and insurance premiums.
Home Equity Loan Disadvantages
Higher Interest Rate Than a HELOC: Home equity loans tend to have a higher interest rate than home equity lines of credit, so you may pay more interest over the life of the loan. Your Home Will Be Used As Collateral: Failure to make on-time monthly payments will hurt your credit score.
Example 1: 10-year fixed-rate home equity loan at 8.75%
If you took out a 10-year, $100,000 home equity loan at a rate of 8.75%, you could expect to pay just over $1,253 per month for the next decade.
With a home equity line of credit, also called a HELOC, you can borrow multiple times against your equity during the draw period. Based on your finances, debt-to-income ratio and credit health, your lender will allow you to borrow up to an approved credit limit.
Now let's calculate the monthly payments on a 15-year fixed-rate home equity loan for $20,000 at 8.89%, which was the average rate for 15-year home equity loans as of October 16, 2023. Using the formula above, the monthly principal and interest payments for this loan option would be $201.55.
The average national interest rate for a 15-year home equity loan is just slightly higher than for the 10-year option at 9.09%. Taking out a $200,000 loan with these terms would result in monthly payments of $2,039.25.
It can have a small impact on your credit score when you apply for one, but a larger one if payments are late or missed. As additional debt, it can ding it — but can also boost it as an enhancement of your total available credit.
Using a home equity loan to pay off debt: How it works
A home equity loan is a second mortgage, meaning that most homeowners will take out a home equity loan while they are still paying off their primary mortgage. You can borrow a lump sum of money with a home equity loan and use the cash to pay down your debts.
Can you use equity release to pay off existing debt? Yes you can, there is no minimum or maximum level of debt you need to have to look at equity release as an option. However, it's more likely to be suitable for you if you have debts that you cannot afford to pay off using your regular income.
If you are able to afford only a fixed amount every month to pay off debt, taking out a home equity loan to pay down your loan balances can help you settle debt more quickly. A lower interest rate means that a greater portion of your monthly payment each month goes toward paying down the principal.
What is the Three-Day Cancellation Rule? This federal rule says you have three business days, including Saturdays but NOT Sundays, to reconsider a signed credit agreement that secures your principal residence and cancel the deal without penalty.
The average U.S. homeowner now has more than $274,000 in equity — up significantly from $182,000 before the pandemic.
A lower credit score doesn't necessarily mean a lender will deny you a home equity loan. Many home equity lenders allow for FICO scores as low as 620, considered “fair,” as long as you meet other requirements around debt, equity and income.
The amount of equity you should have before selling your home can be dependent on multiple factors, such as the state of the market, the amount of inventory available, and your goals after the sale. Generally speaking, however, experts recommend having at least 20% equity when selling a home.
It depends on how much equity you have and your lender. Regardless, though, you can't take out the full amount of equity — so if you have $100,000 in equity, say, you can't simply access $100,000. Most lenders allow you to borrow 80 percent to 85 percent of your home's appraised value.