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The Pros and Cons of a Home Equity Loan

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Maurie Backman
Kristi Waterworth
By: Maurie Backman
Maurie Backman
Maurie Backman
Writer

Maurie Backman is a personal finance writer who covers topics ranging from Social Security to credit cards to mortgages to REITs. She also has an editing background and appears on live podcasts to talk about financial matters.

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 and  Kristi Waterworth
Kristi Waterworth
Kristi Waterworth

Kristi Waterworth has been a writer since 1995, when words were on paper and card catalogs were cool. She's owned and operated a number of small businesses and developed expertise in digital (and paper) marketing, personal finance, and a hundred other things SMB owners have to know to survive. When she's not banging the keys, Kristi hangs out in her kitchen with her dogs, dropping cheese randomly on the floor.

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Our Mortgage Experts

Eric McWhinnie
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Eric McWhinnie
Eric McWhinnie

Eric McWhinnie has been writing and editing digital content since 2010. He specializes in personal finance and investing. He also holds a bachelor’s degree in Finance.

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When you need money in a pinch, borrowing against your home may be a viable solution. But there are pros and cons of home equity loans. Read on to decide whether tapping the equity in your home is the right way to go.

What is a home equity loan?

A home equity loan is a loan in which the lender uses your home as collateral to let you borrow money. If you can't repay your loan, your mortgage lender can seize your property to get its money back.

Your home equity loan works just like any other loan -- you pay back the principal amount you borrowed and interest at a fixed rate over a preset period until your balance is gone.

Pros and cons of a home equity loan

Pros Cons
Easy to qualify for Risk of losing your home if payments aren't made
Lower interest rates Need to sell your home for enough to cover your primary mortgage, your home equity loan, and other real estate fees
Flexible loan terms Certain home restrictions

Advantages explained

  • Easy to Qualify: If you have home equity and a credit score of at least 620, most lenders will approve your loan since your home acts as collateral. With unsecured loans, like personal loans, you need a higher credit score because there's no collateral.
  • Low Interest Rates: Home equity loans typically offer lower interest rates compared to credit cards and personal loans, making them a more affordable borrowing option.
  • Flexible Use: You can use a home equity loan for almost anything, like paying for college or other big expenses. However, if it's not used for home improvements, the loan interest won’t be tax-deductible, though that's usually not a major drawback.

Disadvantages explained

  • Risk of Losing Your Home: If you don’t make payments on your home equity loan, your home is at risk since it’s used as collateral.
  • Challenges When Selling: If you need to sell your home with an outstanding home equity loan, you must sell it for enough to cover the loan balance. If not, you may need to negotiate with the lender, potentially converting the loan to less favorable terms.
  • Restrictions on Your Home: Some lenders may impose restrictions, such as prohibiting you from renting out your home while the loan is being repaid.

TIP

It pays to shop around

Comparing interest rates and terms from different lenders is the best way to get the most competitive rate. Check out today's mortgage rates to get started!

Is a home equity loan right for you?

Because there are pros and cons to taking out a home equity loan, your best bet may be to price out a few different financing options with the best mortgage lenders in your area, calculate your monthly payments, and see which makes the most sense.

If you have a steady job and borrow a reasonable amount against your home, the concern of falling behind on those monthly payments and losing your home may not be so pressing, in which case a home equity loan or mortgage refinance could be your most affordable ticket to accessing the cash you need. Weigh your options carefully before rushing to sign those papers.

The Ascent's best mortgage refinance lenders

Refinancing your mortgage could save you hundreds of dollars for your monthly mortgage payment and secure you tens of thousands of dollars in long-term savings. Our experts have reviewed the most popular mortgage refinance companies to find the best options. Some of our experts have even used these lenders themselves to cut their costs.

Best mortgage refinance lenders

FAQs

  • There are several small differences between home equity loans and HELOCs, but the main difference is how they're structured. Home equity loans are distributed as a lump sum when you close the loan and the amount is fixed from that moment. So, if your home equity loan is for $30,000, you will get a $30,000 check at closing.

    A HELOC, on the other hand, is a type of credit line. You can think of it like a credit card.  You're given a limit to how much you can borrow -- for example, that same $30,000 -- but instead of a check at closing, you just have access to that credit line for a period. You can take all of it out or just some of it for a specific project, and you'll only pay interest on what you've borrowed, up to that $30,000 limit. You can even pay money back to that credit line and charge it up again during your draw period.

  • Home equity loans are generally more expensive to borrow than a primary mortgage, since they're riskier to the bank should you default on your mortgage. The rate will vary based on how risky you are as a borrower, how much of your home's equity remains after the loan is made, and current mortgage rates. Calling around to banks that make equity loans can help you find the best rate possible.