A home equity loan is a type of mortgage that allows you to borrow money against your home’s equity. It may also be called a second mortgage, since it’s usually attached to a home already secured by a first mortgage.
Home equity is the difference between your home’s market value and the amount you owe on your mortgage. For example, if your home is worth $400,000 and your first mortgage balance is $300,000, you have $100,000 worth of home equity.
If you’re a numbers person, here are the steps you’d take to calculate the home equity loan amount with a maximum 85% LTV ratio on a $400,000 home with a $300,000 mortgage balance.
If you’d like to streamline the process, use our home equity loan calculator.
| Pros | Cons |
|---|---|
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Your payment will be fixed and stable each month You may be able to deduct home equity loan interest from your tax bill Your closing costs are typically lower than a cash-out refinance |
You’ll reduce the available equity in your home You’ll have two monthly house payments You could lose your home if you default on your payments |
In many ways, a home equity loan works like a regular, fixed-rate first mortgage.
Terms usually range between five and 30 years, and most lenders set loan-to-value (LTV) ratio limits on how much you can borrow. Your LTV ratio measures how much of your home’s value you borrow, and the maximum LTV ratio for a home equity loan is often 85%.
Although most home equity lenders let you tap up to 85% of your home’s value, some lenders may offer high-LTV home equity loans that allow you to borrow more. Use our home equity loan calculator to estimate how much home equity borrowing power you have.
You’ll typically spend between 2% and 5% of your home equity loan amount on closing costs. Your local banks or credit unions may offer special discounts if you open a checking or savings account and have your payment debited directly from your account.
Guidelines for home equity loans are usually more stringent than first mortgage cash-out refinance loans. Although the rules will vary from lender to lender, you’ll typically need to meet the following general requirements to qualify:
Lenders divide your total debt by your pretax income to calculate your debt-to-income (DTI) ratio. The standard home equity guideline maximum DTI ratio is 43%.
Although lenders may set the bottom score limit at 620, others may set higher minimums between 660 and 680. If you’re looking for a home equity loan with bad credit, expect a higher rate and more limits on your maximum DTI or LTV ratio.
You’ll usually need at least 15% equity to get a home equity loan. However, some specialty home equity loan lenders will set LTV ratios at 90% or higher.
Some home equity lenders allow you to borrow on a second home or investment property, but at much lower LTV limits than a primary residence. You’ll get the best rates and highest LTV ratios if the home equity loan is secured by a home you’re living in.
With this type of refinance, your current first mortgage is replaced with a larger first mortgage and you pocket the difference in cash. Most cash-out refinance programs cap your LTV ratio at 80%, but the lending requirements are more lenient than home equity loans.
Homeowners ages 62 years or older may be able to convert their home equity to cash, monthly income or a line of credit through a reverse mortgage. Rather than having to make a payment on the amount borrowed, the interest is added to the loan each month.
If you prefer to leave your home’s equity alone, you may qualify for a personal loan. The rates are often higher than home equity products, but you won’t have to worry about the lender foreclosing on your home if you default.
If you’re borrowing equity for home renovations, an FHA 203(k) or Fannie Mae HomeStyle® Renovation loan may be a better choice than a home equity loan or cash-out refinance. The big advantage: Lenders use your home’s estimated value after improvements to calculate your maximum loan amount, instead of basing it on the home’s current condition.
A home equity loan makes sense if: