A home equity loan works as a fixed-rate second mortgage: you borrow a lump sum against the equity you’ve built in your house, then repay it in equal monthly installments over 5 to 30 years while your original mortgage stays in place. Because the home secures the debt, rates are lower than credit cards or personal loans, but the lender can foreclose if you fall behind. Most lenders will let you borrow up to 80% to 90% of your home’s appraised value, minus what you still owe on the first mortgage.
What Equity You Can Actually Borrow
Equity is the gap between what your home is worth and what you owe on it. If an appraiser values the house at $400,000 and your mortgage balance is $250,000, you have $150,000 in equity. That’s your starting point, not your borrowing limit.
The number that actually caps your loan is the combined loan-to-value ratio, or CLTV. Lenders add your existing mortgage to the proposed equity loan and divide by the appraised value. Most cap CLTV at 80% to 85%, with some going to 90%.1Fannie Mae. Home Equity Combined Loan-to-Value HCLTV Ratios On a $500,000 home with an 85% cap, total debt can’t exceed $425,000. If your first mortgage is $300,000, the largest equity loan you can get is $125,000.
The valuation comes from a professional appraiser the lender orders, not from your tax bill or your own estimate. Appraisals typically cost $300 to $800 and you pay for them, either upfront or at closing.
What Lenders Check Before Approving You
Three benchmarks decide whether you qualify and at what rate.
Credit Score
Most lenders want a minimum of 680. Some approve scores as low as 620 if the rest of your file is strong, and scores above 720 tend to get the best rates. Moving from the upper 600s into the 700s can save thousands in interest over the life of the loan.
Debt-to-Income Ratio
Your debt-to-income ratio compares total monthly debt payments, including the new equity loan, against gross monthly income. Federal qualified mortgage rules set a general threshold of 43%.2Federal Register. Qualified Mortgage Definition Under the Truth in Lending Act Regulation Z Individual lenders vary; some accept ratios up to 45% or 50% when a borrower has strong credit or cash reserves.3Fannie Mae. B3-6-02, Debt-to-Income Ratios
Combined Loan-to-Value
Even with excellent credit and low DTI, you can’t get more than CLTV allows. This is the ceiling most borrowers hit first.
Minimum Loan Size
Most lenders won’t originate very small equity loans. The typical minimum is $10,000, and some institutions require $25,000 or more. Below that threshold, a personal loan or credit card can be more practical even at a higher rate.
Documentation
Expect to hand over at least two years of federal tax returns along with W-2s or 1099s.4Federal Trade Commission. Home Equity Loans and Home Equity Lines of Credit Salaried workers add recent pay stubs covering 30 days. Self-employed borrowers face more scrutiny and often need profit-and-loss statements or business returns. You’ll also need your latest mortgage statement showing principal balance and escrow status, plus bank and investment statements that show reserves. Discrepancies between your application and supporting documents slow underwriting and can trigger denials.
What You’ll Pay to Close
Closing costs on an equity loan typically run 2% to 5% of the loan amount. On a $100,000 loan, that’s $2,000 to $5,000. Some lenders absorb part or all of the costs to win your business, so it’s worth asking.
- Origination fee, usually 0.5% to 1% of the loan amount
- Appraisal, $300 to $800 for a full appraisal; cheaper desktop or drive-by options exist for smaller loans
- Title search of $75 to $200, plus title insurance where required at roughly 0.5% to 1% of the loan
- Credit report fee, $10 to $100
- Recording fees that vary by county, plus notary fees of $100 to $200
Ask each lender you’re comparing for a Loan Estimate. It’s a standardized form that makes side-by-side comparison straightforward.
Closing Day and Your Three-Day Right to Cancel
Once underwriting clears, you’ll get a Closing Disclosure at least three business days before closing. At the signing table you execute the promissory note (your promise to repay) and the mortgage or deed of trust that gives the lender a security interest in the house.5Consumer Financial Protection Bureau. Mortgage Closing Checklist The disclosure itself spells out the stakes: you may lose the property if you don’t make payments.6Consumer Financial Protection Bureau. Closing Disclosure
Federal law then gives you a safety valve. Under the Truth in Lending Act, you have until midnight of the third business day after closing to cancel for any reason, without explanation.7Office of the Law Revision Counsel. 15 USC 1635 – Right of Rescission as to Certain Transactions If you rescind, you owe no finance charges or fees, and the lender must return any money you paid within 20 days. Miss that window and the lender disburses the full amount in one lump sum.
How You Pay It Back
Home equity loans use fixed interest rates, so the monthly payment doesn’t change from the first installment to the last. Terms usually run 5 to 20 years, with some lenders offering 30. Longer terms lower the monthly payment but raise total interest substantially.
Payments follow a standard amortization schedule. Early on, most of each payment covers interest; over time the balance shifts toward principal. No balloon payments, no rate resets.
Missed payments get expensive fast. Most lenders charge a late fee of about 5% of the monthly principal and interest after a grace period of 10 to 15 days. Because the house is collateral, sustained delinquency can lead to foreclosure. A second mortgage holder can foreclose even when your first mortgage is current, though in practice they usually pursue other remedies unless there’s enough equity to make foreclosure financially worthwhile.
When the Interest Is Tax-Deductible
Interest on a home equity loan can be tax-deductible, but only if you use the money to buy, build, or substantially improve the home that secures it.8Internal Revenue Service. Publication 936, Home Mortgage Interest Deduction Renovating your kitchen or adding a bedroom qualifies. Paying off credit cards or covering tuition doesn’t.
A dollar cap also applies. For mortgages taken out after December 15, 2017, the deduction covers interest on up to $750,000 of total home acquisition debt, or $375,000 if married filing separately.8Internal Revenue Service. Publication 936, Home Mortgage Interest Deduction That ceiling covers the first mortgage and the equity loan combined. If your primary mortgage is already $700,000, only $50,000 of the equity loan qualifies, no matter how much you borrowed for improvements.
You also have to itemize rather than take the standard deduction. For many homeowners, the standard deduction is larger than their total itemizable expenses, which makes the tax benefit moot in practice. Run the numbers before counting on it.9Internal Revenue Service. Real Estate Taxes, Mortgage Interest, Points, Other Property Expenses
How It Compares to a HELOC or Cash-Out Refinance
An equity loan isn’t the only way to tap your equity, and picking the wrong product can cost you.
A home equity line of credit (HELOC) works more like a credit card secured by the house. You draw funds as needed during a set period, usually 10 years, and pay interest only on what you’ve actually withdrawn. HELOCs carry variable rates, so payments can climb if rates rise. Some lenders let you lock in a fixed rate on part of the balance for a fee. HELOCs fit ongoing expenses like a phased renovation better than a single large cost.
A cash-out refinance replaces your first mortgage with a new, larger one and hands you the difference in cash. You end up with one loan instead of two. Closing costs are substantially higher because you’re refinancing the entire balance, not just the new borrowing, so this route only pencils out if you can also secure a lower rate on the refinanced portion than you’re paying now.
Risks Before You Sign
The biggest risk is the one the Closing Disclosure warns about: you can lose your home. The equity lender holds a second lien with the legal right to initiate foreclosure on default, even when the first mortgage is current. Junior lienholders usually pursue other remedies first because foreclosure only makes financial sense when the sale would cover the first mortgage with money left over, but “usually” is not a guarantee to bet the house on.
Falling property values create a different trap. If the market value drops below your combined balances, you’re underwater. There’s no immediate penalty, but you can’t sell without bringing cash to closing, and no lender will refinance a property with negative equity. Anyone borrowing near the CLTV ceiling should think carefully about whether local prices are near a peak.
There’s also the plain arithmetic of ownership. Every dollar borrowed against equity is a dollar you no longer own outright, and when you sell, the equity loan balance comes off the proceeds before you see anything. If you plan to move within a few years, check whether the closing costs and interest are worth it compared to options that leave your equity intact.
Finally, check for prepayment penalties. Federal rules require lenders to disclose them, and many equity loans don’t carry one.10Consumer Financial Protection Bureau. 12 CFR 1026.40 – Requirements for Home Equity Plans Some do, particularly for payoff within the first two or three years. Ask the lender directly and read the terms before signing.