Home Equity Loan

How a Home Equity Loan Really Works

A home equity loan is often called a "second mortgage" because it sits on top of your primary mortgage and is also secured by your property. The lender looks at how much your home is worth today, subtracts what you still owe on your main mortgage, and uses that remaining value as the basis for how much you can borrow.

In practice, most lenders will not let you borrow the full amount of your equity. Instead, they cap the total of your first mortgage plus the home equity loan at a certain percentage of your home's value, often in the 75%–90% range. The exact limit depends on your credit profile, income, and the lender's policies.

Home equity loans typically have:

• A lump-sum disbursement: You receive all the money at closing, which is helpful for one-time, larger expenses.
• A fixed interest rate: Your rate is set at the beginning and does not change, which means your payments are predictable.
• A defined term: Many terms range from 5 to 30 years. Shorter terms mean higher monthly payments but less total interest paid.
• Regular installment payments: You repay the loan in equal monthly payments of principal and interest, similar to a traditional mortgage.

Because your home is the collateral, the approval process typically includes a review of your income, debts, credit history, and an evaluation or estimate of your home's current market value. Closing costs can apply, and while they are often lower than on a first mortgage, they still affect the overall cost of borrowing.

Key Benefits, Risks, and When a Home Equity Loan Makes Sense

Used thoughtfully, a home equity loan can be a practical and relatively low-cost way to access capital. Used carelessly, it can put your home at serious risk. Understanding both sides is essential before you sign.

Potential advantages include:

• Predictable payments: The fixed rate and fixed term make budgeting straightforward, which many borrowers prefer to variable-rate options.
• Access to larger amounts: Because the loan is secured by your home, you may qualify for a higher amount than with an unsecured personal loan or credit card.
• Often lower rates than unsecured debt: Secured lending usually comes with lower interest rates compared with credit cards or personal loans, which can reduce the cost of borrowing.

Key risks to weigh carefully:

• Risk of foreclosure: If you cannot keep up with payments, the lender can pursue foreclosure, and you could lose your home.
• Less flexibility than a line of credit: You receive one lump sum. If you need additional funds later, you must apply for another loan.
• Closing costs and fees: Appraisals, origination fees, and other costs can reduce the net benefit, especially on smaller loan amounts or short time horizons.
• Impact on your overall debt load: You are increasing the amount secured by your home, which can reduce your financial flexibility if your income drops or expenses rise.

When a home equity loan can be a good fit

A home equity loan tends to work best when you have a clear, one-time need for a specific amount of money, a stable income, and a realistic plan for repayment. Common uses include substantial home projects, consolidating higher-interest debts into a single fixed payment, or covering major life expenses where predictability is more important than flexibility.

Before proceeding, compare a home equity loan with alternatives such as a home equity line of credit (HELOC), a cash-out refinance, or an unsecured personal loan. Review the total cost over the full term, not just the monthly payment, and stress-test your budget to ensure you could continue paying even if your income fell or other expenses increased. That level of diligence helps you use the equity in your home as a strategic tool, not a source of unnecessary risk.