What a home equity loan is
A home equity loan lets you borrow a lump sum against the part of your home you own outright. It is a second mortgage: a separate loan, secured by the home, that sits behind your first mortgage. You get the money in one go, and repay it in equal monthly payments at a fixed rate, usually over 5 to 30 years.
People use them for large one-off costs: a renovation, a new roof, college fees, or replacing high-interest debt. Because the home secures the loan, rates are usually lower than on personal loans or credit cards. The flip side is that you can lose the home if you cannot pay.
How much can you borrow?
Lenders cap the combined loan-to-value ratio (CLTV): your first mortgage plus the new loan, divided by the home’s value. The cap is commonly 80%, 85% or 90%, depending on the lender, your credit score and your income.
Equity = home value − mortgage balance
Take a $450,000 home with $250,000 left on the mortgage. Your equity is $200,000, but you cannot borrow all of it. At 85% CLTV the maximum is 450,000 × 0.85 − 250,000 = $132,500. At 80% it would be $110,000; at 90%, $155,000.
The value is set by the lender’s appraisal. If it comes in lower than you expect, the maximum falls with it, so leave yourself some room.
The payment formula
A home equity loan amortizes like any fixed-rate loan:
P = amount borrowed · r = yearly rate ÷ 12 · n = number of monthly payments
The payment never changes. Early payments are mostly interest, later ones mostly principal. The schedule above shows the split for every month and year.
APR: the rate including fees
Closing costs are paid at the start, so you receive less than you borrow but repay the full amount. The APR is the yearly rate at which your payments are worth exactly the cash you actually get. That is why the APR is higher than the interest rate whenever there are fees. The CFPB recommends comparing lenders by APR, because it folds the fees into one number.
Worked example 1: a $60,000 renovation loan
Using the calculator’s starting values: a $450,000 home, $250,000 owed, 85% CLTV, and you borrow $60,000 at 8.25% for 15 years with $1,500 of closing costs.
- r = 0.0825 ÷ 12 = 0.006875 and n = 180
- M = 60,000 × 0.006875 ÷ (1 − 1.006875^−180) = $582.08 a month
- Total interest: $44,775.16
- Cash received after fees: $58,500
- APR: 8.67%, because the payments are measured against $58,500 rather than $60,000
- Combined LTV afterwards: (250,000 + 60,000) ÷ 450,000 = 68.9%
Worked example 2: how the term changes the cost
Same $60,000 at 8.25% with $1,500 of fees:
| Term | Monthly payment | Total interest | APR with fees |
|---|---|---|---|
| 5 years | $1,223.78 | $13,426.51 | 9.33% |
| 10 years | $735.92 | $28,309.89 | 8.84% |
| 15 years | $582.08 | $44,775.16 | 8.67% |
| 20 years | $511.24 | $62,697.45 | 8.60% |
| 30 years | $450.76 | $102,273.59 | 8.52% |
Two lessons. First, a longer term lowers the payment but multiplies the interest: the 30-year loan costs more than seven times as much interest as the 5-year one. Second, fees hurt most on short loans, because they are spread over fewer payments. That is why the 5-year APR is the highest.
Worked example 3: when the amount is capped
You owe $290,000 on a $400,000 home and want $40,000 at 8.25% for 10 years.
- At 80% CLTV the maximum is 400,000 × 0.80 − 290,000 = $30,000. The calculator warns you and works out the payment on $30,000: $367.96 a month.
- At 90% CLTV the maximum is $70,000, so the full $40,000 fits: $490.61 a month and $18,873.26 of interest.
If you are close to the cap, shopping for a lender with a higher CLTV limit, or borrowing less, may be your only options. Higher limits often come with higher rates.
Home equity loan vs HELOC
Both borrow against your home, but they behave very differently.
| Home equity loan | HELOC | |
|---|---|---|
| How you get the money | One lump sum at closing | Draw as needed, up to a limit |
| Interest rate | Usually fixed | Usually variable (prime + margin) |
| Payments | Fixed principal and interest from month one | Often interest-only during a draw period, then higher |
| Interest charged on | The whole loan from day one | Only what you have drawn |
| Best for | A single known cost, steady budgeting | Costs spread over time, flexible needs |
| Main risk | Paying interest on money you do not need yet | Rate rises and payment shock when repayment starts |
If your project has stages, compare with the HELOC calculator. If your first mortgage rate is higher than today’s rates, a cash-out refinance can sometimes replace both loans; the refinance calculator shows when that pays off.
Typical costs to budget for
- Appraisal to confirm the home’s value.
- Origination or application fee charged by the lender.
- Title search, title insurance and recording fees.
- Points, if you pay to lower the rate.
Together these are often 2% to 5% of the loan, though some lenders waive them, sometimes in return for a slightly higher rate. Enter the total under More options to see the APR. The APR calculator can also compare two offers with different fees.
Tips
- Borrow what you need, not what you qualify for. Every extra dollar costs interest for the whole term.
- Match the term to the purpose. A kitchen that lasts 20 years can justify a longer term; a holiday or a car should not be on a 30-year loan.
- Pay extra if you can. On the $60,000 example, $100 extra a month clears the loan after 136 payments instead of 180 and saves $12,362.37 of interest. Check there is no prepayment penalty first.
- Mind your debt-to-income ratio. Lenders check it, and so should you. The debt-to-income ratio calculator shows how the new payment changes it.
- Know the tax rule. In the US, interest is deductible only if you itemize and use the loan to buy, build or substantially improve the home that secures it (IRS Publication 936).
Common mistakes
- Confusing equity with borrowing power. Owning $200,000 of equity does not mean you can borrow $200,000. The CLTV cap always leaves a cushion.
- Comparing rates but not fees. A lower rate with high fees can cost more than a slightly higher rate with none, especially on short loans.
- Using home equity to pay off cards, then running the cards up again. You end up with both debts, and one of them is secured by your home.
- Forgetting the risk. Missed payments on a home equity loan can lead to foreclosure, just like your first mortgage.
The results are estimates based on a fixed rate and monthly payments. Lenders round to the cent and may count interest by days, so their figures can differ slightly. Your Loan Estimate and loan agreement are the final word.