What a home equity loan is and how to get one

A home equity loan lets you borrow money using the difference between what your house is worth and what you still owe on your mortgage. If your house is worth $300,000 and you owe $200,000, you have $100,000 in equity available to borrow against. Lenders will typically let you borrow 80 to 90 percent of that equity, though the exact amount depends on your credit score, income, and how long you have owned the home.

To get a home equity loan, you need to contact a lender — usually a bank, credit union, or mortgage company — and provide proof of your income, your current mortgage balance, and your home's estimated value. The lender orders an appraisal to confirm the value, pulls your credit report, and verifies your employment. If you meet their requirements, they offer you a loan amount and interest rate. You sign the paperwork, and the lender records a second mortgage against your house. The money typically arrives in your bank account within 5 to 10 business days after closing.

Key Takeaways

  • Home equity loans are second mortgages secured by the difference between your home's value and what you owe on your first mortgage.
  • Lenders require a recent appraisal, proof of income, employment verification, and a credit check before approving the loan.
  • Interest rates on home equity loans are usually lower than credit card rates but higher than your first mortgage rate, and the rate is typically fixed for the life of the loan.
  • If you stop paying a home equity loan, the lender can foreclose on your house, so this debt is secured by your home itself.
  • The loan process usually takes 2 to 4 weeks from process to closing, depending on how quickly you provide documents and the lender completes the appraisal.

How lenders decide how much you can borrow

Lenders use a formula called loan-to-value ratio, or LTV. They take your home's appraised value, subtract what you still owe on your first mortgage, and then lend you a percentage of that remaining equity. Most lenders cap this at 80 to 90 percent LTV on the total home value — meaning if your house is worth $300,000, they will not lend you more than $240,000 to $270,000 combined across all mortgages.

Your credit score, income, and debt-to-income ratio also matter. A lender will look at your monthly debt payments — car loans, credit cards, student loans, the new home equity loan itself — and divide that by your gross monthly income. Most lenders want this ratio to stay below 43 to 50 percent. If you earn $5,000 a month and already have $2,000 in monthly debt payments, adding a $500 home equity loan payment might push you over their limit, and they will deny you or offer a smaller amount.

How long you have owned the home affects the decision too. Lenders prefer borrowers who have built equity over time rather than those who bought recently. If you bought your house two years ago and have paid down the mortgage significantly, you are a stronger candidate than someone who closed on their purchase three months ago.

What documents you need to provide

Lenders require consistent documentation across all major home equity loan applications. You will need to provide your most recent pay stubs (usually the last two months), W-2 forms or tax returns for the past two years, and a bank statement showing your savings and checking accounts. If you are self-employed, expect to provide two years of tax returns and possibly a profit-and-loss statement.

You must also bring proof of homeownership — your deed or a recent property tax bill — and your current mortgage statement showing the balance you owe. The lender will order the appraisal themselves, but you may need to provide access to your home for the appraiser to inspect it. Some lenders also ask for a letter of employment from your employer confirming your job title, salary, and how long you have worked there.

If you have had recent credit problems, late payments, or a bankruptcy, the lender will ask for a written explanation. This is called a letter of explanation, and it should be honest and brief — one or two paragraphs describing what happened and why it will not happen again. Lenders use these to decide whether the problem was temporary or a pattern.

How interest rates and terms are set

Home equity loan interest rates are usually fixed, meaning they stay the same for the entire life of the loan. The rate you receive depends on the current market rate, your credit score, the LTV ratio, and how long you have owned the home. A borrower with a 750 credit score might receive a rate 0.5 to 1 percent lower than someone with a 650 score. Rates also vary by lender — shopping with at least three lenders can save you thousands of dollars over the life of the loan.

Loan terms typically run 5, 10, 15, or 20 years. A shorter term means higher monthly payments but less interest paid overall. A 10-year loan on $50,000 at 7 percent interest costs about $584 per month; a 20-year loan on the same amount costs about $398 per month, but you pay roughly $45,000 in interest instead of $20,000.

Some lenders offer home equity lines of credit, or HELOCs, instead of a fixed loan. A HELOC works like a credit card — you have access to a credit limit, you draw money as you need it, and you pay interest only on what you borrow. HELOCs usually have variable interest rates that change with the market, so your payment can go up or down. Fixed-rate home equity loans are simpler to budget for because your payment never changes.

The appraisal process and what happens if your home is worth less than expected

The lender orders an independent appraisal, which costs $300 to $600 and is usually paid by you upfront or rolled into the loan. The appraiser inspects your home inside and out, measures the square footage, checks the condition of the roof and foundation, and compares recent sales of similar homes in your area. The appraisal report arrives within 5 to 10 business days.

If the appraisal comes in lower than you expected, the amount you can borrow shrinks. If you thought your house was worth $300,000 but the appraisal says $280,000, and you owe $200,000 on your mortgage, your available equity drops from $100,000 to $80,000. The lender will offer you a smaller loan amount based on the new value. You can accept the smaller amount, pay for a second appraisal to challenge the first one, or walk away from the loan.

If you walk away, you typically lose the appraisal fee unless the lender agrees to waive it. Some lenders will refund the appraisal cost if you decline the loan within a certain window, but this is not may provide. Always ask about the appraisal fee policy before you start the process.

Closing costs and fees you will encounter

Home equity loans come with closing costs similar to a mortgage. These include the appraisal fee ($300 to $600), title search and insurance ($200 to $400), attorney fees ($500 to $1,500 depending on your state), and recording fees ($50 to $200). Some lenders also charge an origination fee of 1 to 2 percent of the loan amount, though many credit unions and online lenders waive this.

Total closing costs usually run 2 to 5 percent of the loan amount. On a $50,000 loan, expect $1,000 to $2,500 in costs. Some lenders let you roll these costs into the loan balance, so you do not pay them upfront, but this means you pay interest on them for the life of the loan. A $1,500 closing cost rolled into a 10-year loan at 7 percent interest costs you roughly $2,100 by the time you pay it off.

Before you sign the closing documents, you will receive a Closing Disclosure form that lists every fee and the total amount you owe. You have the right to review this for at least three business days before closing. Read it carefully and ask the lender to explain any fee you do not understand.

Why your home becomes collateral and what happens if you cannot pay

A home equity loan is a secured loan, meaning the lender has a legal claim against your house if you stop paying. The lender records a second mortgage on your property, which means if you default, they can foreclose and force the sale of your home to recover their money. This is different from an unsecured loan like a credit card, where the lender has no collateral.

If you miss payments, the lender will typically send you a notice after 30 days of nonpayment. After 120 days, they can begin foreclosure proceedings. The foreclosure process varies by state — some states allow judicial foreclosure (through the courts) and others allow non-judicial foreclosure (the lender can sell the home without court involvement). Either way, if the home sells for less than you owe on both mortgages, you may still owe the difference.

Because your home is at risk, a home equity loan should only be used for expenses you can afford to repay. Common uses include home repairs, debt consolidation, and education costs. Using a home equity loan to fund a risky business venture or to cover living expenses you cannot otherwise afford puts your housing at risk.

Home equity loans versus HELOCs versus cash-out refinancing

A home equity loan gives you a lump sum upfront with a fixed interest rate and fixed monthly payment. You receive all the money at closing and begin repaying it when ready. This works well if you know exactly how much you need and when you need it.

A HELOC is a line of credit you can draw from as needed, similar to a credit card. You pay interest only on what you borrow, and the interest rate is usually variable, meaning it changes with market conditions. HELOCs typically have a draw period (usually 10 years) when you can borrow money, followed by a repayment period when you can no longer borrow and must pay down the balance. HELOCs work well if you need money over time but do not know the exact amount upfront — for example, if you are planning a multi-year home renovation.

Cash-out refinancing means replacing your current mortgage with a new, larger one and taking the difference in cash. If you owe $200,000 on a $300,000 house and refinance for $250,000, you receive $50,000 in cash. The advantage is a single payment instead of two mortgages. The disadvantage is that you reset your mortgage term — if you had 20 years left on your original mortgage, refinancing for 30 years means paying for 30 more years. Refinancing also requires a new appraisal and closing costs, and your interest rate on the entire mortgage may be higher or lower than your original rate depending on market conditions.

Frequently Asked Questions

Can I get a home equity loan if I have bad credit?

Most lenders require a credit score of at least 620, though 640 to 660 is more common. If your score is below 620, some credit unions and online lenders may still work with you, but you will pay a higher interest rate. The worse your credit, the higher the rate. You can also improve your score before explore by paying down credit card balances and making all payments on time for several months.

What if I still owe money on my first mortgage?

You can have a home equity loan while still paying your first mortgage. The home equity loan is a second mortgage, and both lenders have a claim on your home. The first mortgage lender gets paid first if the home is sold. You will have two monthly payments — one for each loan — and both must be paid on time to avoid default.

How long does the whole process take from process to getting the money?

Most home equity loans close within 2 to 4 weeks. The timeline depends on how quickly you provide documents, how fast the appraisal is completed, and whether the lender needs clarification on anything in your process. Online lenders sometimes move faster than traditional banks. You can ask the lender for an estimated timeline when you explore.

Can I use a home equity loan for any purpose?

Legally, yes — once the money is in your account, you can use it for anything. However, lenders may ask what you plan to use the money for, and some may decline to lend if you say you are using it for high-risk purposes like starting a business or paying off gambling debts. Most lenders are comfortable with home repairs, debt consolidation, education, and medical expenses.

What happens to my home equity loan if I sell my house?

When you sell, the proceeds from the sale pay off both your first mortgage and your home equity loan before you receive any money. If the sale price is less than what you owe on both loans combined, you still owe the difference and must pay it from other funds. If the sale price is more than what you owe, you keep the remainder after both loans are paid off.