A home equity loan is a type of second mortgage: It’s a loan with a fixed rate, secured by your
ownership stake (equity) in your home. It offers a specific amount of funds, so it’s best for borrowers
who know exactly how much money they need. As with a regular mortgage, you receive the funds in a
lump sum, then make regular monthly repayments amortized over the term of the loan.
Because your home is the collateral for the loan, the amount you’ll be able to borrow is related to its
current market value. The interest rate you receive on a home equity loan (as with other loans) will vary
depending on your lender, credit score, income, and other factors.
Home equity loan pros and cons
Pros
Attractive interest rates: home equity lenders typically charge lower interest rates compared to the
rates on personal loans and credit cards. This is because home equity loans are a type of secured debt,
meaning they’re backed by some sort of collateral (in this case, your house) — which makes them less
risky for the lender, compared to unsecured debt, which isn’t backed by anything.
Fixed monthly payments: Home equity loans offer the stability of a fixed interest rate and a fixed
monthly payment. This might make it easier for you to budget and pay each month. This also eliminates
the possibility of getting hit with a higher payment with a variable-rate product, like a credit card or
home equity line of credit (HELOC).
Tax advantages: You could be eligible for a tax break, in the form of a tax deduction if you use the loan
proceeds to substantially improve or repair the home. Check with a licensed accountant tax professional
to learn more about this deduction and to determine if it’s available to you.
Cons
Home on the line: Your home is the collateral for a home equity loan, so if you can’t repay it, your lender
could foreclose.
No flexibility: If you’re not sure how much money you need to borrow (you’re planning a big remodeling
project, say), a home equity loan might not be the best choice. Because home equity loans only offer a
fixed lump sum, you run the risk of borrowing too little. On the flip side, you might borrow too much,
which you’ll still need to repay with interest (though you might be able to settle the debt early, if that’s
the case).
Lengthy, costly application: Applying for a home equity loan is akin to applying for a mortgage; though
somewhat simpler, it often means lots of paperwork, a long process and closing costs.
How a home equity loan works
When you take out a home equity loan, the lender approves you for a loan amount based on the
percentage of equity you have in your home. You’ll receive the loan proceeds in a lump-sum and make
fixed monthly installments that include principal and interest payments over a set period. Although
terms vary, home equity loans can be repaid over a period of as long as 30 years.Since the loan is secured by your home, the property is at risk for foreclosure if you can’t repay what you
borrowed. If that happens, it can cause serious damage to your credit score, making it harder for you to
qualify for future loans.
If you use a home equity loan to make home renovations or repairs, the interest you pay on it might be
tax-deductible. According to the IRS, you can deduct interest on a home equity loan that is used to “buy,
build or substantially improve” the property. It must be the collateralized property: If you could take out
a loan on your primary residence to buy a vacation home, the interest wouldn’t be tax-deductible
(because the second home isn’t backing the debt). Also, you must itemize deductions on your return.

Home equity loan requirements

• Lenders have different requirements for home equity loans. Some typical requirements include:
• Credit score: At least in the mid-600s
• Home equity: At least 15 percent to 20 percent
• Employment and income: At least two years of employment history and pay stubs from the past
  30 days
• Debt-to-income (DTI) ratio: No more than 50 percent (Back End)
• Loan-to-value (LTV) ratio: No more than 85 percent
  How long do you have to repay a home equity loan?
  It varies by lender. However, most home equity loans come with repayment periods between five and
  30 years. A longer loan term means you’ll get more affordable monthly payments. That said, you’ll also
  pay far more interest. So, assuming you can afford the higher monthly repayments, selecting a shorter
  term maximizes overall cost.
  The ideal is to find a compromise between the two: the maximum manageable payments and the
  shortest loan term.
  Are there fees associated with home equity loans?
  Home equity loans are essentially mortgages — in fact, “second mortgage” or “second Lien” are
  common terms for them — and often they come with the same sort of surcharges your primary
  mortgage does. Some lenders might require you to pay an origination fee and closing costs — typically
  between 2 percent and 5 percent of the loan balance — for the privilege of borrowing their money. You
  might also pay a home appraisal fee.
  Once the loan proceeds are disbursed to you, late fees could apply if you remit payment after the
  monthly due date or grace period (if applicable). Some lenders also charge a prepayment penalty if you
  decide to pay the loan off early.
  What can you use a home equity loan for?
  Most lenders don’t impose spending restrictions on home equity loans. Common uses include debt
  consolidation for high-interest credit card balances or other loans, home repairs or upgrades, higher
  education expenses and medical debts. Some homeowners also use the funds to start a business,
  purchase an investment property or cover another major purchase.