What’s a home equity loan? A practical guide

What you’ll learn

— What a home equity loan is and how it works

— How to get a home equity loan

— The pros and cons of home equity loans

— Alternative options, like HELOCs and cash-out refinances

Buying a home can open the door to more financial flexibility than many people expect. The equity you build over time can become a resource for covering major expenses and reaching longer-term goals.

One way homeowners access that equity is through a home equity loan. This second mortgage option lets you borrow against your home’s value, using the property as collateral.

Below, we’ll break down what a home equity loan is, how it works, and when it might make sense for your financial situation.

How does a home equity loan work?

A home equity loan lets you turn the equity you’ve built in your home into cash. You can then use this money to cover a wide range of expenses, from debt consolidation to home renovations.

These loans usually come with fixed interest rates and set repayment terms — generally five, 10, or 15 years. Like other mortgages, your monthly payments cover both principal and interest.

Keep in mind that since your home backs the loan, missing payments could put it at risk of foreclosure.

Qualification requirements for a home equity loan

Home equity loan requirements vary by lender, but most follow similar guidelines. Typically, they expect 15–20% equity, a minimum credit score of 680, and a debt-to-income (DTI) ratio of 43% or less.

They also consider your combined loan-to-value (CLTV) ratio, which compares your remaining mortgage balance and any additional loans to your home’s current market value. Most lenders limit home equity loans to about 80–85% of your home’s value based on your CLTV, though some may allow more.

Even if you qualify, ensure your budget can comfortably handle the monthly payments before taking out the loan.

Pros and cons of home equity loans

Securing a lump sum of cash can be tempting, but it’s not without trade-offs. Let’s break down the benefits and risks of home equity loans.

Pros

— Easier to qualify: Home equity loans are more accessible than unsecured loans because your home serves as collateral, so lenders view you as less risky.

— Fixed payments: Rates are fixed, keeping monthly payments predictable and helping you budget.

— Lower interest rates: These loans usually offer lower interest rates than unsecured debt, such as credit cards or personal loans**.**

— No restrictions: You can spend the loan money however you like.

Cons

— Your home is at risk: Because your property secures the loan, missing payments could lead to foreclosure.

— Interest accrues on the full balance: You pay interest on the entire mortgage balance, even if you don’t use the funds all at once.

— High closing costs: You can expect to pay 3–6% of your total loan amount in closing costs, so factor them into your borrowing decision. 

What 3 steps are needed to get approved for a home equity loan?

Taking out a home equity loan is a simple process. Here are three steps to take.

1. Estimate your home equity and CLTV

Equity determines not only how much you can borrow, but also whether you qualify at all. Start by checking your home’s market value on a platform like Zillow or Redfin. Then, subtract your remaining mortgage balance to estimate how much equity you have.

For example, if your home is worth $500,000 and you still owe $300,000, your equity is $200,000 — or 40%.

Once you choose a lender, they’ll order a home appraisal to get a professional estimate and confirm your exact equity. While some lenders do offer a no-appraisal home equity loan, it's not the norm.

Next, calculate your CLTV by adding your remaining mortgage balance to the amount you want to borrow. Then, divide that total by your home’s market value. 

Using the same example:

— Existing mortgage: $300,000

— New loan: $100,000

— Total loans: $300,000 + $100,000 = $400,000

— Home value: $500,000

Divide $400,000 by $500,000, and your CLTV is 80%.

2. Review your credit profile

Check the key metrics lenders use to evaluate borrowers. Doing this will give you an idea of how likely you are to qualify and what terms you might get. Look at your:

— Total debt burden

— Credit score

— Debt-to-income ratio

— Payment history

— Credit utilization ratio

— Recent hard credit inquiries

3. Shop around and choose a lender

Apply for pre-approval with multiple lenders to find the best deal on a home equity loan. Then, review their interest rates, terms, and fees to pick the one that fits your needs. If you want to skip the hassle of shopping around, Better may be for you. We streamline the process by getting you pre-approved in as little as three minutes.

...in as little as 3 minutes – no credit impact

Alternatives to home equity loans

If a home equity loan doesn’t sound quite right for your situation, you still have alternatives. Let’s dive into some of the most common ones.

Home equity lines of credit (HELOCs)

HELOCs are called home equity lines of credit because they let you borrow against your equity with a revolving credit account rather than a lump sum. This approach works like a credit card: You get a preset limit, withdraw funds as needed, and pay interest only on what you use. The draw period typically lasts about ten years, during which payments are usually interest-only. This keeps monthly installments lower while the principal balance stays the same.

After the draw period ends, the repayment period begins, and you start paying both principal and interest. Keep in mind that HELOCs generally have variable interest rates that can change over time with market conditions.

Cash-out refinances

A cash-out refinance replaces your existing mortgage with a new, larger one. You use the new loan to pay off your original mortgage, and any remaining funds are yours to keep. Cash-out refinances sometimes come with lower interest rates than home equity loans. But, this can depend on market conditions and your credit profile.

Get pre-approved and lock in a great rate with Better

Home equity helps fund major expenses, consolidate debt, and invest in home improvements. With home equity loans, you get a lump sum at a fixed interest rate, making monthly payments predictable and helping you plan your budget.

If home equity lending fits your needs, Better can offer an easy-to-use mortgage application. Looking for something different? Apply for a HELOC.

When you’re ready to move forward, you can close quickly and get your keys up to 10 days faster than the industry average.

Get pre-approved today and access your equity.

...in as little as 3 minutes – no credit impact

FAQ

What should I consider before applying for a home equity loan?

Evaluate how comfortably you can repay the loan since using your home as collateral carries a risk of foreclosure. Look at your financial goals, too. If you plan to fund a big renovation that increases your home’s market value, a home equity loan could be a smart choice. On the other hand, using extra money for a vacation or other non-essential experience may be riskier, because the debt lasts longer than the benefit

How much equity do I need for a home equity loan?

Check your combined loan-to-value ratio. While lenders don’t have a universal minimum, a CLTV of roughly 80–85% is a common benchmark.