What is a Home Equity Loan, and When Can I Use It?

If you’re a homeowner, you may have heard of a home equity loan, but what exactly is it — and when does it make sense to use one?

Whether you’re planning a major renovation, consolidating high-interest debt, or covering an unexpected cost, a home equity loan can offer access to significant funds at competitive rates. However, since your home secures the loan, it’s important to understand how it works and when it’s the right move.

This guide explains the fundamentals of home equity loans, how they differ from HELOCs, when they’re most useful, and when to steer clear.

What is a Home Equity Loan?

A home equity loan lets you borrow a lump sum of money by using the equity in your home as collateral.

Equity is the portion of your home’s value that you actually own. You can calculate it by subtracting your remaining mortgage balance from your home’s current market value. For example:

If your home is worth $300,000 and you owe $180,000, you have $120,000 in equity.

Most lenders allow you to borrow up to 80%–85% of your home’s value, minus your existing mortgage. In the example above, you could potentially borrow around $60,000 to $75,000.

Because your home backs the loan, you’ll often get lower interest rates than unsecured personal loans or credit cards — but it comes with the risk of foreclosure if you fall behind on payments.

How Does a Home Equity Loan Work?

Often referred to as a second mortgage, a home equity loan delivers a lump sum that you repay in fixed monthly payments over a set term — typically between 5 and 30 years.

Step-by-Step: How a Home Equity Loan Works

1. Determine Your Equity: The lender assesses your home’s value and subtracts what you owe.

2. Apply for the Loan: You’ll submit income verification, credit history, debt info, and may need a home appraisal.

3. Receive Funds: Upon approval, you receive a lump-sum payment.

4. Repay Over Time: You’ll make fixed payments each month, with consistent principal and interest amounts.

Home Equity Loan vs. HELOC: What’s the Difference?

While both options use your home as collateral, they serve different needs.

Dive deeper: Home Equity Loan vs. HELOC

When Should You Use a Home Equity Loan?

A home equity loan is best used for large, one-time expenses that offer long-term value. Here are some smart ways to use one:

1. Home Renovations

Kitchen remodels, roof replacements, or energy-efficient upgrades can increase your property’s value — making this one of the most strategic uses of your equity.

2. Debt Consolidation

If you’re carrying high-interest credit card debt, using a home equity loan to consolidate it may lower your interest rate and simplify payments.

Just make sure not to rack up new debt once your balances are paid off.

3. Educational Expenses

Some homeowners use equity to fund tuition or other school-related costs. However, it’s wise to weigh this against federal student loan options first.

4. Medical Emergencies

For large medical bills, a home equity loan may provide quick access to funds. This should be a last resort, given the risk of tying health expenses to your home.

5. Starting a Business

Entrepreneurs sometimes use home equity to launch or expand a small business. This can offer lower interest rates than traditional business loans, but the risk is significant if the business fails.

When Not to Use a Home Equity Loan

There are several scenarios where using a home equity loan could do more harm than good.

• Unstable Income: Without a reliable paycheck, fixed payments can become a serious burden.

• Poor Spending Habits: If you’re already struggling with debt, adding more may only dig the hole deeper.

• Luxury or Non-Essential Purchases: Using your home to pay for vacations, cars, or shopping sprees is a risky move.

• Short-Term Ownership: If you plan to sell your home soon, the loan payoff and fees may outweigh any short-term benefit.

Pros and Cons of Home Equity Loans

How to Qualify for a Home Equity Loan

Each lender sets its own criteria, but you’ll generally need to meet the following:

• At least 15%–20% equity in your home

• Good credit score (typically 620+; 700+ for best rates)

• Stable income and employment

• Low debt-to-income ratio (ideally under 43%)

Lenders may also require a new home appraisal to confirm your property’s value.

Frequently Asked Questions (FAQs)