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If you’ve been steadily making payments on your home loan and enjoyed watching your home appreciate in value, you likely have some home equity available to borrow against. A home equity loan could be one way to get cash to pay for renovations or other expenses.
Home equity loans provide a lump-sum loan, and your home serves as collateral. But what are the benefits of a home equity loan, and are there drawbacks to consider? Let’s look at the pros and cons of a home equity loan, how it works, and details on alternatives to a home equity loan as well.
Key Points
• Home equity loans provide a lump sum of cash, using your property as collateral.
• Key benefits include access to large amounts of money, relatively low interest rates compared to credit cards, and potential tax deductibility when funds are used for home improvements.
• Primary drawbacks involve the risk of foreclosure and the inflexibility of a one-time lump-sum payout.
• Home equity loans are ideal for borrowers with sufficient equity and good credit scores who have a fixed-cost project or purchase, such as a home renovation or debt consolidation.
• Alternatives like a home equity line of credit (HELOC) or cash-out refinance provide different draw structures and flexibility for those whose needs do not fit a lump-sum loan.
How a Home Equity Loan Works
Here’s the rundown on what a home equity loan is: A home equity loan lets you borrow a lump sum, with your home guaranteeing the loan. Weeks after the loan funds are deposited in your account, you’ll begin making monthly payments toward the principal, plus interest. A home equity loan is a second mortgage, so you’ll have two monthly payments to make if you’re still repaying your first mortgage.
Interest rates are often lower on home equity loans vs. personal loans, which tend to be unsecured loans. If you fail to make your home equity loan payments, however, the lender could foreclose on your home.
Home equity loans are often used when homeowners need a large sum for a defined purpose, such as a home renovation. They are also sometimes used to consolidate debt. The borrower uses the proceeds from the home equity loan to pay off higher-interest debts, such as credit card balances, and then makes one monthly home equity loan payment instead of multiple payments to creditors.
Advantages of a Home Equity Loan
Home equity loans are popular for good reason. When homeowners consider home equity loan pros and cons, they can see that home equity loans offer several benefits.
Large sums One of the key advantages of a home equity loan is that borrowers can often access large sums. Personal loans may top out at $100,000 with many lenders; however, some lenders allow much larger loan sizes with home equity loans, provided a borrower has the required equity. Your maximum loan amount will be based on your home’s value, how much you still owe on your original home loan, and your overall financial profile, such as your credit score and other debts.
Relatively low interest rates One plus of a home equity loan is that you can often borrow a larger sum of money at a lower interest rate than you could with other methods of financing. The average home equity loan rate in fall 2026 hovers around 8.60%, far lower than the interest rates on credit cards, which have averaged above 20.00% for more than three years.
Fixed interest rates Home equity loans typically have a fixed interest rate. This means monthly payments are predictable for the life of the loan, which can range from five to 30 years.
Potential tax break When the funds you borrow with your home equity loan are used to buy, build, or substantially improve your home, you may be able to deduct the interest you pay on the loan on your federal tax return. Talk with a tax advisor and keep a record of how loan funds are spent on your home.
Disadvantages of a Home Equity Loan
On the list of home equity loan pros and cons, the key drawback of a home equity loan is the potential for foreclosure. However there are other potential downsides to consider:
The lump sum conundrum Borrowing a lump sum means you’ll need to know at the outset how much money you need. So if you’re borrowing for a renovation, you’ll need to have a solid estimate upfront. If the costs balloon, you can’t add to your home equity loan amount — you’ll have to explore other ways of financing your project.
No break from payments With a home equity loan, you begin making payments on the entire loan amount immediately. With some other forms of financing, you can enjoy a period of interest-only payments before the larger principal-plus-interest payments kick in.
Recommended: Home Equity Loan vs. Second Mortgage
When a Home Equity Loan Might Be a Good Idea
A home equity loan could be a good fit for your borrowing needs if you meet the qualification criteria for the loan and you have a solid idea of how much cash you require. To qualify for the loan, most applicants will need a minimum of 15% equity in their home. (Your equity is your home value minus your mortgage debt; divide the answer by your home value to arrive at a percentage of equity.)
Lenders also typically look for a credit score of at least 640, and many require 680 or better. Your debt-to-income (DTI) ratio will need to be below 50%, meaning the total of your monthly debt payments should be less than half of your gross monthly income.
If you can qualify for the loan, it could be a good idea for you if you need a large, defined sum of money — especially if you are using the funds to renovate your home, as that could allow you to deduct the interest payments on your federal taxes.
“Defined” is an important word. If you are renovating, get thorough estimates and factor in a cushion in case you go over budget. If you are consolidating credit card debt, add up all that you owe and borrow only what you need. Then avoid taking on new debt. Try to borrow enough, but not more than you need, because you will begin paying interest on the full amount immediately.
When a Home Equity Loan Might Not Be a Good Idea
Notwithstanding the benefits of a home equity loan, these loans aren’t a good idea for everyone. Because a home equity loan is disbursed as a lump sum, it’s generally not a good idea to borrow this way when you don’t know precisely how much money you need. Maybe you’re replacing your kitchen flooring, getting new cabinets, and need to pay a plumber to move the location of the kitchen sink, but you haven’t figured out if you also need new appliances. In this case, you might want a more flexible way of financing your renovations.
A home equity loan also isn’t a wise move if you think you might want to sell your property in the next few years. Home equity loans have closing costs, and the entire loan amount will likely be due if you sell your home, so it will be paid from the proceeds of your sale. Some home equity loans also have penalties if you pay off your loan early in the process.
And of course, a home equity loan is a bad idea if you think there’s financial uncertainty in your future. Make sure you have a plan in place to repay what you borrow before signing for the loan. If your employment is on shaky ground or you have other significant debt payments coming due, you may want to hold off.
Alternatives to Consider
A home equity loan isn’t your only option if you want to get equity out of your home. Here are some popular alternatives:
A home equity line of credit (HELOC) uses your home as collateral, like a home equity loan, so may offer an attractive interest rate when compared with an unsecured personal loan. But the HELOC vs home equity loan experience is quite different. With a HELOC, you get a line of credit that you can draw from as you wish, up to the credit limit, over a draw period that is typically 10 years. One key difference between a HELOC and home equity loan is that during the draw phase of a HELOC, you often need to pay only interest on the amount you’ve borrowed. So in the short term, the monthly cost of a HELOC could be lower than that of a home equity loan.
You could also consider a type of mortgage refinance called a cash-out refinance. With a cash-out refi, you take out a new home loan that is larger than the balance remaining on your original loan. You pay off your original loan and have the remaining cash to use as you wish. You then begin making payments on the new mortgage. Typically, a refinance is a good idea only if you can also benefit from a lower interest rate than you have on your current home loan.
Recommended: 8 Alternative Options to HELOCs
The Takeaway
Once you understand when home equity loans are a good idea, you can decide whether to move forward and borrow against your equity. The benefits of a home equity loan include a relatively low interest rate when compared with other loan types, plus the opportunity to borrow a large sum and the potential for some or all of the interest to be tax deductible. Before you apply, check interest rates from multiple lenders to see who offers the best rate and terms for your situation.
SoFi now offers home equity loans. Access up to 85%, or $750,000, of your home’s equity. Enjoy lower interest rates than most other types of loans. Cover big purchases, fund home renovations, or consolidate high-interest debt. You can complete an application in minutes.
FAQ
What credit score do you need for a home equity loan?
Some lenders will approve a home equity loan for a borrower with a credit score of 640, but many require a score of 680 or better. And for the best interest rates, it may help to have a score of 700 or more.
Is home equity loan interest tax deductible?
The interest on a home equity loan may be deductible on federal taxes if the money from the loan is used to buy, build, or substantially improve the home.
How much can you borrow with a home equity loan?
Some lenders allow homeowners to borrow up to $750,000 with a home equity loan, but the amount borrowed will also depend on the homeowner’s equity level. Generally, lenders will allow loans of up to 85% of your equity level, assuming your credit score, debt-to-income ratio and other measures of financial health are up to their standards.
Does taking out a home equity loan hurt your credit score?
Taking out a home equity loan can cause a temporary, minor drop in your credit score because the lender will do a hard credit inquiry as part of its loan approval process. If you make your loan payments on time, however, a home equity loan will likely help your credit score in the long run.
What happens if you can’t repay a home equity loan?
A home equity loan uses your home as collateral, so missed payments can result in the lender beginning the foreclosure process. If you are struggling to make loan payments, reach out to your lender to try to negotiate a solution.
Photo credit: iStock/ABRAHAM GONZALEZ FERNANDEZ
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