How a Home Equity Loan Works, Rates & Requirements

How a Home Equity Loan Works, Rates, Requirements & Calculator

By Douglas Sorto

19 Feb

A home is more than just a place to live—it’s an investment. And as you build equity in your home, you gain access to a financial tool that can help you achieve big goals. Whether you're looking to renovate your home, consolidate debt, or cover major expenses, a home equity loan can be a smart way to tap into your home’s value.

In this guide, we’ll break down how a home equity loan works, the requirements to qualify, and how you can calculate your borrowing potential.

‍What Is a Home Equity Loan?

A home equity loan is a type of loan that allows homeowners to borrow against the equity they have built in their home. It is often called a second mortgage because it is separate from your primary mortgage but uses your home as collateral.

The loan is given as a lump sum with a fixed interest rate and repayment period.
Monthly payments remain fixed, making budgeting easier.
Homeowners can use the funds for various purposes, including home improvements, medical bills, or education expenses.

How a Home Equity Loan Works

Home equity loans work similarly to a traditional mortgage:

You borrow a fixed amount based on your home’s equity.
You receive the funds in a one-time lump sum.
You repay the loan over a set term (typically 5-30 years) with fixed monthly payments.
Interest rates are typically lower than personal loans or credit cards since your home secures the loan.

The amount you can borrow is generally up to 80-85% of your home’s equity, minus the balance of your existing mortgage.

Average Year-Over-Year Equity Gain per Borrower by State

Homeowners across the U.S. have seen their home values grow significantly, leading to increased equity. While equity gains vary by location, some states experience higher-than-average increases. Factors such as local real estate demand and market conditions impact these numbers.

To determine your potential equity, consider using a home equity calculator, which estimates your borrowing power based on your home’s value and mortgage balance.

Special Considerations

Before taking out a home equity loan, consider:

Risk of Foreclosure: Since your home is collateral, defaulting on payments can result in losing your home.
Closing Costs: Some lenders charge fees similar to those of a primary mortgage, including appraisal and origination fees.
Tax Deductibility: Interest on home equity loans may be tax-deductible if the funds are used for home improvements

What Is a Home Equity Line of Credit (HELOC)?

A HELOC is another way to borrow against home equity, but it works more like a credit card:

You get access to a revolving line of credit instead of a lump sum.
Interest rates are usually variable.
You can borrow and repay as needed during the draw period (typically 5-10 years).

Home Equity Loans vs. HELOCs

Feature	Home Equity Loan	HELOC
Payout Type	Lump sum	Revolving credit
Interest Rate	Fixed	Variable
Repayment	Fixed monthly payments	Interest-only during draw period then repayment period starts
Best For	Large one-time expenses	Ongoing expenses like home renovations

Advantages and Disadvantages of a Home Equity Loan

Pros:‍

✅ Fixed interest rates for predictable payments.
✅ Lower rates than credit cards and personal loans.
✅ Can be used for large expenses like home improvements or debt consolidation.

Cons:

❌ Your home is at risk if you default.
❌ Upfront fees and closing costs may apply.
❌ Less flexible than a HELOC if you need funds over time.

Home Equity Loan Requirements

To qualify for a home equity loan, lenders typically require:

A credit score of 620 or higher (higher scores get better rates).
At least 15-20% equity in your home.
A debt-to-income (DTI) ratio below 43-50%.
Proof of stable income and employment.

Average Home Equity Interest Rates

Home equity loan rates vary based on market conditions, lender policies, and your creditworthiness. As of 2025, average rates range between 6-10%, depending on loan terms and risk factors

Example of a Home Equity Loan

If your home is worth $400,000 and you owe $250,000 on your mortgage, you have $150,000 in equity. If a lender allows you to borrow up to 85% of your equity, you could qualify for a loan of around $85,000.

Are Home Equity Loans Tax Deductible?

Yes, but only if the loan is used for home improvements. If you use it for other expenses (like paying off credit cards), the interest is not deductible under IRS rules.

Can You Have a HELOC and a Home Equity Loan Simultaneously?

Yes, but qualifying for both depends on your total home equity and financial profile. Lenders will evaluate your loan-to-value ratio (LTV) and DTI ratio to ensure you can afford multiple loans.

The Bottom Line

A home equity loan can be a great way to access funds for major expenses, especially with fixed rates and predictable payments. However, it’s important to borrow responsibly and consider alternatives like a HELOC if you need more flexibility.

Before applying, compare home equity loan rates, check your credit score, and consult with a lender to determine your best options.