How Does A Home Equity Loan Work?

Gina Pogol
The Mortgage Reports contributor

Increasing Values Create Home Equity Opportunities

If you’re like many homeowners, you bought or refinanced your home with a low-interest fixed mortgage. You want to keep that nice low rate, but you’d also like some extra cash. And you can have it with a home equity loan.

With prices rising in many housing markets, homeowners are converting home equity to cash with HELOANs and HELOCs.

Verify your new rate (Oct 20th, 2020)

What Is A Home Equity Loan?

Home equity loans are mortgages. They are secured by your property, and if you don’t make your payments, you can lose your house to foreclosure. Just like you can with a “regular” mortgage.

A home equity loan can be structured to deliver a lump sum of cash at closing, or a line of credit that can be tapped and repaid, kind of like a credit card.

The most important difference between home equity loans and first mortgages is that home equity loans are a little riskier for lenders. They are called “second mortgages” or  “junior liens,” because if you end up in foreclosure, the lender with the home equity mortgage only gets paid off after the lender with the first mortgage.

If the foreclosure sale doesn’t bring in enough to cover both the first and second mortgage, the second mortgage lender loses out.

This leads to a few differences in the way first mortgages and home equity loans work.

Home Equity Loan Interest Rates

When you apply for home equity financing, expect higher interest rates.

That’s because of the added risk to the lender. Fixed home equity interest rates for borrowers with excellent credit are about 1.5 percent higher than the current 15-year fixed mortgage rate.

Home equity interest rates vary more widely than mainstream first mortgage rates, and your credit score has more impact on the rate you pay. An 80-point difference in FICO scores can create a six percent difference in a home equity interest rate.

Home equity lines of credit (HELOCs) have variable interest rates. This means your monthly payment depends on your loan balance and the current interest rate. Your payment and rate can change from month to month.

Home equity loans can have variable interest rates, but most of the time, the rate and payment are fixed.

Differences Between First And Second Mortgages

Besides the interest rate, there are a few other distinctions between first and second mortgages.

Expect a shorter loan term. Home equity loans and lines of credit terms range from five to 20 years, with 15 years being the most common. The shorter repayment time reduces risk to lenders.

You won’t be able to borrow as much. Many mortgage programs allow you to finance 95, 97 or even 100 percent of your home’s purchase price. Most home equity lenders max out your loan-to-value at 80 to 90 percent.

Your loan fees may be lower. HELOC lenders, for example, often absorb most of all of the fees. Home equity loan fees for title insurance and escrow are usually much lower than those for first mortgages.

Your lender may not require a full appraisal. That could save you hundreds in charges.

Home equity loans usually close much faster than first mortgages. You may get your money in a couple of weeks.


The home equity loan delivers a lump sum of cash at closing. If your interest rate is fixed (this is the norm), you’ll make equal monthly payments over the loan’s term, until it’s paid off.

The fixed rate and payment makes the HELOAN easier to include in your budget.

It’s a smart loan when you need all the money at once and want a fixed interest rate. For example, if you want to consolidate several credit card accounts into a single loan, or if you need to pay a contractor upfront for a major renovation, a HELOAN is a great choice.


The home equity line of credit, or HELOC, offers more flexibility, but makes budgeting harder. HELOCs have a drawing period, in which you’re allowed to use funds as needed, up to your credit limit. You use it as much as you like during these first years. There is a minimum payment — usually the amount needed to cover the interest due that month.

When the drawing period ends, you can no longer tap the credit line and must repay it. With a variable interest rate, your payment could change every month. Some HELOCs allow you to fix your interest rate when you enter the repayment period. These are called “convertible” HELOCs.

HELOCs are ideal for expenses that occur over a longer period of time, or as a source of emergency cash. You only pay interest on the amount that you use.

For instance, you might take a HELOC to serve as an emergency cash source for your business. You can use it to pay college tuition twice a year. HELOCs are also great for home improvements that take place over time, and in stages.

What Are Today’s Home Equity Mortgage Rates?

As noted above, home equity loan rates are more sensitive to your credit rating that other mortgages. Rates can vary more between lenders, which makes it important to shop for a good deal. To get an accurate quote, you’ll need to provide an estimate of your credit score and your property value.

Verify your new rate (Oct 20th, 2020)

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