What Are the Pros and Cons of a Home Equity Loan?

How much equity can I borrow from my home?

The amount you can borrow depends on your home’s market value, your mortgage balance, and your lender’s specific requirements. Most lenders allow you to borrow up to 80% to 85% of your home’s equity.

Home equity loan example

Here’s a simple example to show how much you might be able to borrow with a home equity loan, using the computation instructions above:

• Your home’s appraised value: $350,000
• Outstanding mortgage balance: $150,000
• Maximum LTV ratio: 80%

Using the formula:

(Current home value x Maximum LTV ratio) — Outstanding mortgage balance

• $350,000 (home value) x 0.80 (LTV) = $280,000
• $280,000 – $150,000 (mortgage balance) = $130,000

In this case, you could borrow up to $130,000 with a home equity loan.

»Learn more: Don’t want to do the calculations yourself? Our Home Equity Calculator makes it easy to estimate your home equity in just a few steps, so you can better understand how much value you’ve built over time.

Pros and cons of a home equity loan

When deciding whether a home equity loan is the right financial move, it’s important to carefully weigh both the benefits and potential drawbacks. Understanding the advantages can help you make the most of your home’s value. At the same time, being aware of the disadvantages ensures you’re prepared for any risks involved.

Pros of a home equity loan

• Fixed interest rate: Your interest rate stays the same for the entire loan term, so your monthly payments won’t suddenly change. This makes it easier to plan your budget and know exactly what to expect each month.
• Lower interest rates: Because your home backs the loan, lenders typically offer lower interest rates than you’d get with options like personal loans or credit cards. That lower rate can help you save money over time, especially on larger expenses.
• Lump-sum payout: You’ll receive the money all at once, making a home equity loan a good option for big, one-time expenses like a major renovation, medical bills, or high-interest debt payment.
• Flexible usage: Once you get the funds, you can typically use them for a variety of expenses, giving you more control over where the money goes.
• Potential tax benefits: If you use the loan for qualifying home improvements, the interest you pay may be tax-deductible. Be sure to check with a tax professional to see if you qualify.
• Home value boost: Using the funds for renovations or upgrades may help increase your home’s value, potentially making the loan work harder for you over time.
• Debt consolidation: A home equity loan can help you roll high-interest debts, like credit card balances, into one payment and may lower the amount of interest you pay overall.
• Access to larger funds: Because the loan is based on your home equity, you may be able to borrow more than you could with other types of unsecured loans.

Cons of a home equity loan

• Foreclosure risk: Because your home secures the loan, missing payments or failing to repay the balance could put your property at risk of foreclosure.
• High upfront costs: Appraisal fees, loan origination fees, and closing costs can add up, so you’ll want to factor these expenses into your decision.
• Increased overall debt: A home equity loan increases your overall debt, which could affect your budget and your ability to qualify for other loans in the future.
• Loan overuse: Having access to a large amount of money can make it tempting to borrow more than you actually need or can comfortably afford to repay.
• Upside-down home loan: If your home’s value drops after taking out the loan, you could end up owing more than your property is worth, leaving you “underwater” on your mortgage.
• Long repayment period: Home equity loans often have terms lasting 10 to 30 years, which means you could be making payments for a long time.
• Limited repayment flexibility: Unlike a HELOC, which lets you borrow, repay, and borrow again as needed, a home equity loan comes with a fixed amount, term, and payment schedule.
• Less equity down the road: Using your home equity now means you’ll have less available if you need funds later for emergencies, future projects, or other opportunities.
• Significant money strain: Unexpected changes like losing your job or facing a major expense could make it harder to keep up with your monthly payments.

What fees will I pay with a home equity loan?

You will typically pay closing costs of 2% to 5% of the loan amount, but they can be as low as 1%, depending on the borrower, the lender, and your property situation. Home equity loan costs can include:

• Loan origination fee (0.5%-1%)
• Appraisal fee ($300–$500)
• Credit report pull ($10–$100)
• Document prep and attorney fees (Hourly rate or a percentage of the loan)
• Notary or signing and filing fee ($20–$100)
• Title insurance (0.5%-1% of purchase price)
• Title search fee ($100–$450)

How do I qualify for a home equity loan?

Before approving a home equity loan, lenders typically evaluate the following criteria:

• Maximum 43% debt-to-income (DTI) ratio: Your DTI ratio, which is the percentage of your monthly income spent on debt payments, should be below 43%. A lower ratio improves your chances of approval and may result in better terms.
• Minimum 620 credit score: While some lenders may accept lower scores, a credit score of 620 or higher is often required to qualify. Higher scores can help secure a lower interest rate. You’ll also typically need stable income and employment to qualify.
• Maximum 85% LTV ratio: Lenders generally cap the total amount you owe on your home (including the new loan) at 80% to 85% of the property’s current value. This ensures you retain a buffer of equity even after borrowing.

Alternatives to home equity loans

If a home equity loan doesn’t feel like the right fit, you still have other ways to access funds without tapping into your home’s equity. From flexible credit options to loans with different repayment structures, exploring alternatives can help you find the option that best matches your financial goals.

• Home equity line of credit (HELOC): A HELOC works like a credit card, providing a revolving line of credit with variable interest rates. It’s ideal for ongoing or unpredictable expenses, like multiple home improvement projects.
• Cash-out refinance: This option replaces your existing mortgage with a larger loan, allowing you to cash out a portion of your home’s equity. A cash-out refinance can be a good choice if current mortgage rates are lower than what you’re currently paying.
• Personal loan: For smaller, unsecured amounts, a personal loan offers faster approval and no risk to your home. However, interest rates are typically higher than those for equity-based loans.
• Reverse mortgage: If you’re 62 or older, a reverse mortgage allows you to convert your home equity into cash without monthly payments. This option is primarily designed for retirees seeking additional income.

Can I use home equity to buy a new home?

If you’re thinking about using a home equity loan to buy a new home, consider a Buy Before You Sell program as a more flexible alternative. These solutions allow you to make a competitive offer on your next home without waiting to sell your current one, which can be especially helpful in a fast-moving market. Unlike a home equity loan, you won’t take on additional long-term debt or risk borrowing against your home’s value.

This solution can help eliminate the stress of timing two transactions. Here’s a quick look at how HomeLight’s Buy Before You Sell works:

Should I get a home equity loan?

A home equity loan can be a good option if you need extra cash and already have a solid plan for paying it back. It’s usually a better fit for homeowners with steady finances, manageable debt, and a clear reason for borrowing, like making improvements that could boost their home’s value.

Before taking out a home equity loan, it’s important to have an accurate understanding of your home’s current market value. This helps you determine how much equity you can safely borrow without overextending yourself. It also gives you a clearer picture of your financial options and helps you plan your loan wisely.

Use HomeLight’s Home Value Estimator to get a fast, reliable estimate and make confident decisions about your home equity.

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