How Does a Home Equity Loan Work?

Written by Banks Editorial Team
4 min. read
Written by Banks Editorial Team
4 min. read

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You can use the equity in your home to fund renovations or repairs, pay off high-interest debt, cover a costly emergency, or however else you see fit. Home equity loans are one of many ways to tap into your home’s equity, but you should understand how they work before you apply. 

These loan products offer many benefits to homeowners. Unfortunately, there are also some downsides to consider, and you want to conduct a cost-benefit analysis to determine if a home equity loan is right for you. 

What is Home Equity?

Home equity is the difference between your home’s current value and your outstanding mortgage balance. So, if your home is worth $375,000 and you owe $225,000 on your mortgage, you have $150,000 of equity in your home. 

Home Renovation Loans

Learn how the RenoFi ReFi cash-out refinance home renovation loan allows you access up to 80% of your home’s projected value after renovation.

How Does Home Equity Work?

Home equity fluctuates with specific actions you take or when the housing market changes.

How Do You Build Home Equity?

Here are a few ways you can build home equity: 

  • Make a generous down payment. The more money you put down on your home, the lower your loan amount will be, which helps give you instant equity in your home. 
  • Improve your home. If you make the right improvements to your home, the value could increase. 
  • Pay off your mortgage faster. You can pay more than the minimum each month or double up on payments to rapidly decrease the principal owed on your mortgage. Many lenders allow homeowners to make principal-only payments to speed up the process. 
  • Stay put. It’s tempting to move around when you grow bored with your home. However, staying put could pay off big if the housing market improves as your home will likely increase in value and boost your equity. 

How Much Home Equity Do You Have?

To determine the amount of equity you have, consider getting your home appraised to know how much it’s worth. Also, contact your mortgage company to get the loan payoff amount. Deduct this figure from your home’s value to calculate your home’s equity. 

What Can You Use Home Equity For?

Many consumers tap into their equity to buy a new home, pay off high-interest debt, fund renovations, pad their nest egg, or purchase a big-ticket item. 

Home Renovation Loans

Learn how the RenoFi ReFi cash-out refinance home renovation loan allows you access up to 80% of your home’s projected value after renovation.

Home Equity Loans

Home equity loans are a viable way to access the equity in your home. 

How Does a Home Equity Loan Work?

A home equity loan is a debt product you can use to borrow between 75 to 80 percent of the equity you have in your home. It’s structured as a fixed installment loan, and you will make equal monthly payments over a period of five to 30 years. 

Here are a few examples of how home equity loans work: 

Scenario 1: 

You purchased your home for $385,000 early last year. The housing market has since skyrocketed, and it’s now valued at $455,000, bringing your equity to $80,000 since you still owe $375,000. After inquiring with a lender about a home equity loan, you qualify for a loan of 75 percent of your home’s equity, or $60,000. If you accept the offer, you will receive $60,000 in cash at closing, and you’ll also be responsible for your original mortgage payments and payments on the new loan of $60,000. 

Scenario 2: 

A few years ago, the sales price on your home was $250,000, and you currently owe $235,000. Market conditions have improved significantly, and your home is now worth $325,000. You confirm the market value by having an appraisal done, which means you have $90,000 in equity. If the lender approves you for a home equivalent to 80 percent of your home’s equity, you will qualify for a loan of $72,000. When you close on the loan, you will receive the process in a lump sum and continue to make payments on your original mortgage. Plus, payments on the new loan of $72,000 will commence shortly after. 

Benefits of a Home Equity Loan

Here are some key benefits of a home equity loan: 

  • Fixed interest rate
  • Predictable monthly payments
  • Extended repayment period
  • Tax-deductible interest

How Does a Home Equity Line of Credit (HELOC) Work?

Similar to a home equity loan, a HELOC lets you borrow against your home’s equity. Some lenders extend loans of 75 to 95 percent, minus the outstanding loan balance. Another key difference is the way you access funds. 

HELOCs are set up as a line of credit so that you can draw against them for a period of up to 10 years. Once the draw period ends and you no longer have access to the funds, you will repay the remainder of what you owe for up to 20 years.

How to Get a Home Equity Loan or a HELOC

Shop around at brick and mortar and online banks for home equity loans and HELOCs. Inquire about qualification criteria, loan limits, the application process, and loan terms before moving forward. 

Are you looking to fund a home improvement project? Check out the loan products offered by RenoFi, as they allow you to borrow up to 90 percent of your home’s value after renovations. Plus, they have dedicated advisors standing by to connect you with exceptional credit union lenders in their network to secure the funding you need. 

FAQs About How a Home Equity Loan Works

Here are a few frequently asked questions about how a home equity loan works.

What can you use a home equity loan for?

Once the loans are disbursed to your account, you’re free to use the funds as you see fit.

Is home equity loan interest tax-deductible?

If you use a home equity loan to make renovations to your home, the interest you pay may be tax-deductible. Consult with a licensed tax professional or accountant to discuss your situation.

Can you sell your house if you have a home equity loan?

Yes, but you will have to pay off the outstanding balance of the home equity loan at closing. If you price the home right, the proceeds received from the buyer could take care of the balance.

How long do you have to repay a home equity loan?

It depends on the lender. Most offer repayment terms between five and 30 years.

How much home equity can you borrow?

Traditional lenders’ home equity loans are generally limited to 75 to 80 percent of your home’s value, minus what you owe your mortgage. However, RenoFI increases your borrowing power by allowing you to borrow up to 90 percent of your home’s after-renovation value.

RenoFi

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All data provided by the Home Mortgage Disclosure Act, at cfpb.gov updated Dec, 19
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