What Are the Pros and Cons of a Home Equity Loan?

How much equity can I borrow from my home?

The amount you can borrow depends on your home’s market value, your mortgage balance, and your lender’s specific requirements. Most lenders allow you to borrow up to 80% to 85% of your home’s equity.

Home equity loan example

Here’s a simple example to show how much you might be able to borrow with a home equity loan, using the computation instructions above:

• Your home’s appraised value: $350,000
• Outstanding mortgage balance: $150,000
• Maximum LTV ratio: 80%

Using the formula:

(Current home value x Maximum LTV ratio) — Outstanding mortgage balance

• $350,000 (home value) x 0.80 (LTV) = $280,000
• $280,000 – $150,000 (mortgage balance) = $130,000

In this case, you could borrow up to $130,000 with a home equity loan.

Check your home’s value for free: You can get a ballpark estimate of what your home might be worth today by using HomeLight’s Home Value Estimator. Simply answer a few questions about your home and receive a preliminary estimate in a matter of minutes.

Pros and cons of a home equity loan

When deciding whether a home equity loan is the right financial move, it’s important to carefully weigh both the benefits and potential drawbacks. Understanding the advantages can help you make the most of your home’s value. At the same time, being aware of the disadvantages ensures you’re prepared for any risks involved.

Pros of a home equity loan

• Fixed interest rate: You’ll have predictable payments, making it easier to manage your budget over the life of the loan.
• Lower interest rates compared to personal loans or credit cards: Securing the loan with your home typically results in lower rates, saving you money in the long term.
• Lump sum payout: This option is ideal for one-time expenses such as a major renovation, medical bills, or high-interest debt payment.
• Flexible usage: Funds can be used for nearly any purpose, allowing you to allocate the money in a flexible way.
• Potential tax benefits: If the loan is used for home improvements, the interest may be tax-deductible (consult a tax professional for specific guidance).
• Home value boost: If used for renovations, you might increase your home’s market value, making the loan an investment in your property.
• Debt consolidation: Paying off higher-interest debts, like credit cards, can simplify your finances and reduce overall interest costs.
• Access to substantial funds: The borrowing limits, based on your equity, often allow access to larger sums than unsecured loans.

Cons of a home equity loan

• Foreclosure risk: Since your home is collateral, failing to repay the loan could result in losing your property.
• High upfront costs: Appraisal fees, loan origination fees, and closing costs can add up, reducing the immediate financial benefit.
• Increased overall debt: Taking out a home equity loan adds to your total debt burden, which could impact future borrowing.
• Loan overuse: Access to significant funds might tempt you to borrow more than you can comfortably repay.
• Upside-down home loan: If property values fall, you could owe more than your home is worth, leaving you “underwater” on your mortgage.
• Long-term repayment commitment: Home equity loans often have terms lasting 10 to 30 years, which could be a lengthy financial obligation.
• Limited flexibility in repayment: Unlike a HELOC, which offers a revolving credit line, home equity loans have fixed terms and schedules.
• Reduced equity for future needs: Borrowing against your home now means you’ll have less equity available for emergencies or opportunities later.
• Significant money strain: Unexpected life events, such as job loss or medical emergencies, could make it difficult to manage payments.

What fees will I pay with a home equity loan?

You will typically pay closing costs of 2% to 5% of the loan amount, but they can be as low as 1%, depending on the borrower, the lender, and your property situation. For example, a recent HomeLight lender survey found that homeowners typically request to borrow close to $100,000 against their equity, resulting in $2,000 to $5,000 in fees.

Home equity loan costs can include:

• Loan origination fee (0.5%-1%)
• Appraisal fee ($300–$500)
• Credit report pull ($10–$100)
• Document prep and attorney fees (Hourly rate or a percentage of the loan)
• Notary or signing/filing fee ($20–$100)
• Title insurance (.5%-1% of purchase price)
• Title search fee ($100–$450)

Read the fine print carefully: In addition to the costs listed above, some lenders charge a prepayment penalty fee if you pay off your loan early.

How do I qualify for a home equity loan?

Before approving a home equity loan, lenders typically evaluate the following criteria:

• Maximum 43% debt-to-income (DTI) ratio: Your DTI ratio, which is the percentage of your monthly income spent on debt payments, should be below 43%. A lower ratio improves your chances of approval and may result in better terms.
• Minimum 620 credit score: While some lenders may accept lower scores, a credit score of 620 or higher is often required to qualify. Higher scores can help secure a lower interest rate. You’ll also typically need stable income and/or employment to qualify.
• Maximum 85% LTV ratio: Lenders generally cap the total amount you owe on your home (including the new loan) at 80%–85% of the property’s current value. This ensures you retain a buffer of equity even after borrowing.

Alternatives to home equity loans

If a home equity loan isn’t the best option for your situation, consider these alternatives:

• Home equity line of credit (HELOC): A HELOC works like a credit card, providing a revolving line of credit with variable interest rates. It’s ideal for ongoing or unpredictable expenses, like multiple home improvement projects.
• Cash-out refinance: This option replaces your existing mortgage with a larger loan, allowing you to cash out a portion of your home’s equity. It can be a good choice if current mortgage rates are lower than what you’re currently paying.
• Personal loan: For smaller, unsecured amounts, a personal loan offers faster approval and no risk to your home. However, interest rates are typically higher than those for equity-based loans.
• Reverse mortgage: If you’re 62 or older, a reverse mortgage allows you to convert your home equity into cash without monthly payments. This option is primarily designed for retirees seeking additional income.

Can I use home equity to buy a new home?

If you’re thinking about using a home equity loan to buy a new home, consider a Buy Before You Sell program as a more flexible alternative. These solutions allow you to make a competitive offer on your next home without waiting to sell your current one, which can be especially helpful in a fast-moving market. Unlike a home equity loan, you won’t take on additional long-term debt or risk borrowing against your home’s value.

This solution can help eliminate the stress of timing two transactions. Here’s a quick look at how HomeLight’s Buy Before You Sell works: 

Should I get a home equity loan?

A home equity loan can be a great option if you need access to cash and have a clear repayment plan. It’s best suited for homeowners with stable finances, a manageable debt-to-income ratio, and a reliable purpose for the funds, such as increasing the home’s value through improvements.

Before taking out a home equity loan, it’s important to have an accurate understanding of your home’s current market value. This helps you determine how much equity you can safely borrow without overextending yourself. It also gives you a clearer picture of your financial options and helps you plan your loan wisely. Use HomeLight’s Home Value Estimator to get a fast, reliable estimate and make confident decisions about your home equity.

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