Homeowners can leverage their home equity to borrow money, whether to finance a large purchase or consolidate high-interest debt. A home equity loan (HELOAN) gives borrowers a lump sum that’s secured with their home as collateral.
Read on for an in-depth look at home equity loans, including how they work, potential risks, and how they compare to other financing options.
Table of Contents
What Is a HELOAN?
What is a HELOAN? A home equity loan, or HELOAN, lets you borrow against the equity in your home. Put simply, home equity is the difference between the current value of your home and how much you owe on your mortgage.
More facts about what a home equity loan is: With a HELOAN, you receive funding upfront as a lump sum. The loan usually comes with a fixed interest rate and a repayment term of five to 30 years.
HELOAN Meaning and Definition
A HELOAN (home equity loan) lets you borrow a lump sum of money using your home’s equity as collateral. Technically, because you are borrowing against your home equity, a HELOAN is a second mortgage. It typically features a fixed interest rate and predictable monthly payments, making it ideal for large expenses like debt consolidation or home improvements
Recommended: Second Mortgage vs. Home Equity Loan
How a HELOAN Works
A HELOAN is a financing option that can be used for a variety of expenses. The total amount you can borrow depends on the total equity you have in your home.
Lenders typically calculate home equity as the difference between a home’s fair market value and the remaining mortgage balance. For example, if your home is worth $600,000 and you still owe $450,000 on your mortgage, you’d have $150,000 in home equity (or 25% home equity).
The amount you can borrow with a HELOAN is not equal to your total home equity. Generally, lenders let borrowers access a maximum of 80% equity, though it’s possible to get up to 90% in some circumstances.
HELOAN repayment typically begins soon after funds are disbursed with loan terms ranging from five to 30 years depending on the loan amount and borrower preferences. Fixed interest rate HELOANs are most common, so borrowers can expect predictable monthly payments. If used for home renovation costs, keep in mind that interest paid on HELOANs could qualify for a tax deduction.
As noted above, HELOANs use your property as collateral, meaning that a lender can foreclose on your home if you are unable to make payments.
Key Features of a HELOAN
A HELOAN has several key features that distinguish it from other types of home equity loans.
• Borrow what you need: Loan amounts could be higher than other financing options and you can request only what you need.
• Fixed interest rates: You’ll know the cost of borrowing upfront for the entire loan term.
• Predictable monthly payments: Like a mortgage, you’ll have a set monthly payment that includes the principal and interest.
• Potential tax benefits: HELOAN interest pays could be eligible for tax deductions if the funds are used for home renovations or improvements.
Recommended: Mortgage Interest Deduction Explained
HELOAN vs. HELOC: What’s the Difference?
A HELOAN isn’t your only option for home equity financing. You might consider a home equity line of credit (HELOC) and how a HELOC vs. home equity loan compares in meeting your financial goals.
Both HELOANs and HELOCs use your home as collateral and let you borrow around 80% to 90% of your home equity. However, they differ in how funding is allocated.
Whereas a HELOAN gives you a lump sum amount upfront, a HELOC works as a revolving line of credit that you can borrow from continuously (up to a fixed amount). With a HELOC, you typically have a draw period of five to 10 years during which funds can be taken out as needed.
Another key difference in the HELOC vs. home equity loan comparison is repayment structure. Required monthly payments on a HELOC are typically limited to interest on the amount withdrawn to date during the draw period. Afterward, the HELOC enters the repayment period and borrowers must begin repaying both the principal and interest over the loan term (often 10-20 years).
Keep in mind that HELOCs are available with both fixed and variable interest rates. Also note that there is one other equity-based borrowing option: a cash-out refinance. In this scenario, you take out a new mortgage for more than you currently owe on your home loan. You get the extra amount in cash to use as you wish. This is generally only a good idea if you can improve on your mortgage rate with a refi and lower your payments.
Common Uses for a HELOAN
A HELOAN can be used for a variety of expenses, making it a popular financing option for its flexibility. Below are some common uses for a HELOAN.
• Debt consolidation: Paying down high-interest debt like credit cards with a HELOAN could save on interest and reduce monthly expenses.
• Home renovations: Upgrading your home can increase your property value and interest paid on the HELOAN may be tax deductible if funds are used to improve your property.
• Education costs: Tapping into home equity can help fund higher education expenses if interest rates are lower than student loan rates.
• Emergency expenses: Unlocking home equity is an option to cover unforeseen expenses like medical bills or a roof repair.
Risks to Consider Before Getting a HELOAN
What’s a HELOAN without a few cautionary notes? There are some potential financial risks to consider.
While the upfront cash offered by a HELOAN could get you out of a financial jam, It’s important to assess your ability to repay a HELOAN alongside your primary mortgage. Failing to make payments on either loan could risk losing your home in foreclosure.
When budgeting for a HELOAN, it’s also a good idea to factor in closing costs, which typically range from 2% to 5% of the loan amount.
Using your home equity could also increase your vulnerability to an underwater mortgage if local real estate values decrease. Also known as an upside-down mortgage, an underwater mortgage occurs when the money you owe on your HELOAN and mortgage exceed the fair market value of the home.
How to Qualify for a HELOAN
Borrower qualifications vary by lender but your credit score, payment history, and existing home equity are key factors to determine the total amount you qualify for. Lenders may also require proof of homeowners insurance for a HELOAN.
Lenders often cap the maximum home equity you can borrow at 80%. This is calculated using your loan-to-value (LTV) ratio, which compares the combined total of the primary mortgage and HELOAN against your property value. Again, lenders often require a LTV ratio of 80% or less to qualify for a HELOAN.
Let’s use the example above of a homeowner with a $600,000 property and $450,000 mortgage balance. They’d be able to borrow up to $30,000 with a HELOAN to keep their LTV ratio at 80% or less.
The Takeaway
A HELOAN gives homeowners flexible financing to pay for a range of expenses. Generally, you’ll need to have at least 20% home equity to qualify. But using your home as collateral risks foreclosure if you fail to make payments, so it’s important to consider how much you can afford to borrow as well as other financing options.
SoFi now offers flexible HELOC options to turn your home equity into cash. Access up to 85% of your home equity, or $350,000, to finance home improvements or consolidate debt. Competitive interest rates and repayment terms up to 20 years could result in lower monthly payments versus other loans. And the online application process is quick and convenient.
Unlock your home’s value with a home equity line of credit from SoFi.
FAQ
What is the difference between a HELOAN and a home equity loan?
A HELOAN and home equity loan (HELOAN) are two names for the same financing option. They let you turn your home equity into cash that can be used for a variety of purposes.
How much can you borrow with a HELOAN?
How much you can borrow with a HELOAN depends on your home value and existing home equity. Borrowers usually set a maximum loan-to-value ratio of 80%, meaning that what you owe on a mortgage and HELOAN combined is capped at 80% of the property value.
What credit score do you need for a HELOAN?
While it’s possible to qualify for a HELOAN with poor credit, you may need a credit score of at least 680. Lenders also consider your debt-to-income ratio, payment history, and other factors.
Can you pay off a HELOAN early?
It’s possible to pay off a HELOAN early to save on interest, but it’s important to check if you’ll have to pay early termination fees for doing so.
Is a HELOAN tax deductible?
The interest paid on a HELOAN could be tax deductible if used for certain uses. Namely, home improvements and renovations meet the tax deduction requirements. Like mortgages, there are limitations on how much interest can be deducted.
Photo credit: iStock/ArLawKa AungTun
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