Here’s How a Home Equity Loan Works
If you are a homeowner who has equity in your home, you can tap into that equity through a home equity loan. A home equity loan allows you to borrow money by using the value of your home as collateral for the loan. Here’s a step-by-step look at how these loans work.
How does a home equity loan work?
1. Determine your net worth
Home equity is calculated by taking the current market value of your home and subtracting the outstanding balance of your mortgage. For example, if your house is worth $300,000 and you owe $200,000 on your mortgage, you have $100,000 in equity.
2. Apply for a loan
You’ll need to apply for a home equity loan from a bank, credit union or online lender the same way you did for your original mortgage. The lender will review your income, credit score, employment status, and outstanding debt to determine your creditworthiness and maximum loan amount.
3. Set the loan amount
Most lenders will allow you to borrow up to 85% of the equity in your home. From the example above, with $100,000 in equity, you can get a home equity loan of up to $85,000.
4. Receive a lump sum payment
Unlike a home equity line of credit ( HELOC ), where you borrow as you need it, a home equity loan provides funds as a lump sum payment immediately upon closing the loan.
5. Make monthly payments
You’ll repay the loan over a fixed term, such as 10 or 15 years, with a fixed interest rate and equal monthly payments, just like a conventional mortgage . Home equity loans are installment loans with a specific repayment date.
6. Maintain mortgage payments
Your home equity loan is separate from your original mortgage. You will need to continue making regular mortgage payments in addition to payments on your new home equity loan.
Home equity loans allow you to access some of your home’s equity for things like home renovations , debt consolidation , college tuition , or other major expenses. Just keep in mind that your home is securing the debt, so defaulting could put you at risk of foreclosure.