What is a Home Equity Loan?
We explore how the home equity loan works, its benefits and how it compares with other loan products so you can determine whether it’s right for you.
Updated 
11 min. read
If you’ve been considering ways to access funds by leveraging the value of your home, a home equity loan may be worth exploring. These loans can be helpful when covering major expenses such as funding a home renovation, consolidating debt, or major purchases like college tuition and weddings.
Learn what a home equity loan is and how this popular financing option works.
What is a home equity loan?
A home equity loan, sometimes called a HELOAN, is a loan that allows homeowners to borrow a lump sum by using the equity in their home as collateral.
Because a HELOAN is taken out in addition to your existing mortgage and uses your home as collateral, it’s sometimes referred to as a "second mortgage" or "second lien." It provides funds upfront in one payment, making it well-suited for significant expenses. It also offers predictable monthly payments, helping borrowers plan their finances with greater ease.
HELOANs can cater to various needs, but before applying for a home equity loan, homeowners should know the approximate equity they have in their property as it will help them determine if the product is a good fit for their needs and goals.
What can a home equity loan be used for?
A home equity loan is a reliable option for turning the equity in your home into usable funds. With enough equity built up, it can serve as an effective solution for various financial needs. Here are just some of the ways you can use a home equity loan:
- Home Renovations: Repairs or upgrades can improve your home’s functionality, your lifestyle and boost your home’s value
- Debt Consolidation: Streamline your finances by combining higher-interest debts into a single, manageable monthly payment.1
- Large Purchases: Secure funding for essential expenses that may be challenging to cover upfront.
- Emergency Funds and Medical Bills: Access funds to manage unforeseen expenses – like medical bills or emergencies – when your savings aren’t enough.
- Property Investments: You can also allocate funds towards an investment property to grow your finances when market conditions are favorable.
Eligibility and borrowing limits for HELOANs: How much can I borrow, and do I qualify?
The process of securing a HELOAN starts with evaluating the equity in your property, which can be calculated as: Home Equity = Current Home Value − Outstanding Mortgage Balance
In many cases, lenders may require a formal appraisal from a state-certified or licensed appraiser to get an accurate estimate of your home’s current market value.
How much can you borrow with a HELOAN?
Once you’ve figured out your home equity, the next question is often, “How much can I borrow?” You can use a borrowing power calculator2 to estimate how much you might qualify for.
As a general rule, home equity loans typically start at $5,000 and come with repayment terms ranging from 5 to 20 years (or even 30 years) at fixed interest rates. Most lenders allow borrowers to access 80% to 85% of their home’s value, minus the remaining mortgage balance.
Borrowers repay the loan in fixed monthly installments over the term of the loan, offering stability and predictability. Here's an example to clarify how borrowing limits work:
Say your home is valued at $500,000, and you owe $100,000 on your mortgage. If your lender approves borrowing up to 80% of your home’s value, the calculation would look like this:
In this scenario, you’d be eligible to borrow up to $300,000 with a HELOAN.
How to qualify for a HELOAN
When evaluating your application, lenders will look at multiple factors, including your income, credit history, equity you have in your home, current mortgage balance, and other debt or financial obligations.
Typically, homeowners need at least 15% to 20% equity in their property to be eligible for a home equity loan. Along with sufficient equity, lenders also look for a strong credit score and a low debt-to-income ratio, calculated by comparing your total monthly debt payments to your gross monthly income.
Meeting these criteria can position you as a credible borrower and increase your chances of approval.
What to expect when applying for a HELOAN
Once you've grasped the basics – such as eligibility criteria and borrowing limits – let's dive deeper into the application process, associated fees, and repayment terms for a HELOAN.
Applying for the loan
To begin the process for a home equity loan, you'll need to fill out an application, provide supporting financial documents, and allow the lender to perform a credit check. Using this information, the lender will evaluate your eligibility and determine the interest rate you qualify for, based on their criteria and the details of your financial profile.
A lender will often ask that your home be appraised to ascertain its value before they can finalize the amount of the loan and approve your application. Assuming everything moves forward successfully, the next step is the closing of the loan.
Closing of the loan
When closing your home equity loan, you'll encounter closing costs typically ranging between 2% to 5% of the loan amount. These costs can either be paid out-of-pocket or rolled into the loan, based on your preference (some lenders like B M O may even waive closing costs3). You'll also sign the necessary paperwork to officially finalize the agreement.
The repayment period
Once your home equity loan closes, repayment kicks off right away. You'll pay back the full amount (principal + interest) through monthly installments at a fixed interest rate over an agreed-upon term. You can use our home equity loan payment calculator2 to estimate monthly payments.
Keep in mind that these payments are in addition to your primary mortgage, so ensure your budget can handle the added expense.
Unlike other options, such as variable-rate HELOCs, HELOANs offer predictability in repayment; giving customers the ability to anticipate their payment amounts and budget accordingly.
Key advantages and limitations of a HELOAN
There are times when a HELOAN is a great choice and other times when it may not be right for you. Your financial situation, your goals and what you anticipate doing with the funds can impact your decision.
Advantages of a HELOAN
- Predictability: Fixed interest rates ensure that your monthly payments remain constant throughout the life of the loan, making financial planning and budgeting more straightforward.
- Low interest rates: HELOANs typically offer lower interest rates compared to other lending products such as credit cards or personal loans, due to the loan being secured by your home equity.
- Flexibility: The funds from a HELOAN can be used for a wide range of purposes, from home renovations to consolidating high-interest debt, education expenses, or major purchases.
- Potential tax benefits: If the loan proceeds are used for significant home improvements, the interest paid on a HELOAN may be tax-deductible, in accordance with IRS regulations.4
Limitations of a HELOAN
- Less flexibility: Unlike a HELOC, a home equity loan provides a lump sum with fixed repayment terms, which means you can’t borrow additional funds or adjust the payment schedule once the loan is issued.
- Risk of foreclosure: Because your home is used as collateral, failure to make timely payments can lead to foreclosure, putting your property at risk.
- Fees & costs: Home equity loans often come with one-time costs like application, appraisal, and title search fees, as well as recurring expenses such as annual maintenance fees. Some lenders may also impose prepayment penalties, so reviewing the loan terms thoroughly is essential.
- Interest on full amount: Borrowers are required to pay interest on the entire loan balance, even if they only use a portion of the funds.
How home equity loans differ from HELOCs
Home equity loans and home equity lines of credit (HELOCs) both unlock your home’s equity, but their distinct structures can shape how well they fit your financial needs.
Let’s dive into the key features to help you choose the right option.
| Key Features | HELOAN | HELOC |
|---|---|---|
| Structure | Lump-sum loan amount disbursed upfront | Revolving line of credit that allows borrowing as needed |
| Repayment Terms | Fixed payments of principal and interest | Payments depend on the amount borrowed; typically, interest-only during the draw period |
| Interest Rate | Fixed interest rate | Variable interest rate (may have the option to lock portions of your line at fixed rates) |
| Borrowing Flexibility | One-time lump sum; no ability to borrow additional funds | Ongoing flexibility to borrow, repay, and borrow again within the draw period |
| Draw Period Duration | Not applicable (no draw period; lump sum is disbursed upon closing) | Typically 10 years, after which borrowing ends and repayment begins |
| Repayment Period Duration | Commonly 15–30 years; fixed for the life of the loan | Typically 10–20 years after the draw period ends |
| Interest Payments | Interest applies to the entire lump-sum loan amount | Interest applies only to the amount borrowed |
| Best For | Large, one-time expenses | Irregular or ongoing expenses |
If you're unsure how much you’ll need, a HELOC may be a better fit – it lets you borrow what you need, repay it, and borrow again when needed.
For a more in-depth comparison, check out our article: Home equity line of credit vs. home equity loan: Which is better?
Alternative financing options to consider
If neither a home equity loan nor a home equity line of credit is a good fit for your situation, there are other options.
HELOAN vs Cash-out refinancing
A home equity loan acts as a second mortgage that you pay in addition to your primary mortgage. On the other hand, a cash-out refinance replaces your existing mortgage with a new one, often with revised terms. With a cash-out refinance, you’ll take out a new loan that is larger than your current mortgage balance. The difference between the new loan amount and the remaining balance on your old mortgage is disbursed to you in cash, which you can use for various financial needs – minus any closing costs or fees.
Cash-out refinancing can be advantageous if you qualify for a lower interest rate, reducing borrowing costs over the life of the loan.
HELOAN vs Personal loan
If you prefer to avoid using your home as collateral, a personal loan or personal line of credit might be a better option for you. Similar to home equity products, personal loans can either be disbursed as a lump sum or structured as a revolving line of credit. However, unlike home equity loans or HELOCs, personal loans are unsecured – meaning they don’t require collateral such as your home.
That said, unsecured loans may come with higher interest rates and lower borrowing limits due to the added risk for the lender.
HELOAN vs Credit Cards
And, of course, you can always turn to a credit card when funds are needed. Like a personal loan, a credit card doesn’t require you to own a home to access funds. It also doesn’t have a draw or repayment period. You’ll just need to make monthly payments plus interest if you carry over your balance each month. Of course, those credit card rates will be higher than those of home equity loans.
5 Tips for using a home equity loan responsibly
When leveraging a home equity loan, it’s crucial to manage it wisely to ensure financial stability and protect your most valuable asset – your home. Here are some expert tips to help you use a HELOAN responsibly:
- Assess Your Financial Situation: Before taking out a HELOAN, take a comprehensive look at your financial health. Ensure that your income and expenses are stable enough to support the additional monthly payments without straining your budget.
- Borrow Only What You Need: It can be tempting to borrow the maximum amount available, but it's important to only take out what you truly need. Remember, you'll be paying interest on the total sum borrowed, so keep it as low as possible.
- Create a Repayment Plan: Develop a solid plan to repay the loan. Knowing exactly how you’ll manage the monthly payments over the loan term can prevent financial stress and ensure you stay on track.
- Consult a Financial Advisor: If you're unsure about any aspect of using a HELOAN, seeking advice from a financial advisor can provide personalized guidance and help you make informed decisions based on your unique financial situation.
To recap
So, what exactly is a home equity loan? It’s essentially a way to tap into the value of your home by receiving a lump sum of cash, secured by your home’s equity. With fixed interest rates, HELOANs offer the peace of steady and predictable monthly payments, making them a solid choice for homeowners planning major investments or expenses.
If you’re ready to explore a home equity loan, take time to assess your equity, review your budget, and compare lenders to ensure you’re making the best choice. Speak with a trusted financial advisor if you’re unsure and remember that careful planning is key when using your home as collateral.
Home Equity Loan Frequently Asked Questions
Yes, a home equity loan functions as a second mortgage since it is secured by your home’s equity and is subordinate to your primary mortgage.
The interest on a home equity loan may be tax-deductible if the loan proceeds are used for qualifying expenses such as buying, building, or improving your home.4
Yes, you can pay off a home equity loan early by making additional payments toward the principal balance. However, you may need to pay a prepayment penalty depending on your lender.
Yes, you can refinance a home equity loan by obtaining a new HELOAN, a new HELOC, or by refinancing into a larger first mortgage.
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Have questions?
footnote 1 Please consult with your financial advisor for the benefits and drawbacks between unsecured debt and secured debt and the protections each provide the consumer.
footnote 2 Calculator is provided by Leadfusion Inc., which is not affiliated with B M O. The calculator provides estimates. We do not guarantee their accuracy or applicability to your circumstances. Results depend on many factors, including the assumptions you provide. Leadfusion may have different privacy and security standards than B M O. Visit its website at www.leadfusion.com to review its privacy policy.
footnote 3 Closing Cost and Fee Information: B M O will pay closing costs for loans secured by a owner-occupied 1 to 4 family residence. Closing costs include appraisal charges, credit report, flood determination, title insurance, document recording fees and mortgage and government taxes. You may also be required to pay real estate taxes and items such as prior lien release fees. If the line amount if greater than $500,000, you are responsible for mortgage and government taxes as well as title fees in Alabama, Arkansas, Connecticut, Florida, Kansas, Hawaii, Idaho, Minnesota, Mississippi, New Jersey, New Mexico, Oklahoma, Pennsylvania, Tennessee & District of Columbia. If you pay your loan account in full within 36 months, a closing cost recoupment fee may be charged to recover the closing costs we paid on your behalf.Insurance Information: You must obtain property insurance and may be required to obtain flood insurance.
footnote 4 B M O does not provide tax or legal advice. You should consult a tax advisor for information regarding any tax impacts associated with your loan.