What Are the Pros and Cons of a Home Equity Loan?

Persistently high interest rates and rising home prices have kept many would-be sellers on the sidelines but not out of the game. In 2024, home equity lending rose to its highest levels since 2008, with borrowers tapping into amounts nearly 70% greater than 16 years ago. If you are considering this option, you’ll want to weigh the pros and cons of a home equity loan.

When you need extra cash for a big expense, such as home improvements, college tuition, or consolidating debt, tapping into your home’s equity might be a good solution. In this post, we’ll break down the pros and cons of home equity loans to help you decide if it’s the right choice for you.

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What is a home equity loan?

A home equity loan is a type of loan that lets you borrow money using your home as collateral. Often referred to as a “second mortgage,” it allows you to access a lump sum of cash based on the equity you’ve built in your property.

Unlike a home equity line of credit (HELOC), which functions more like a credit card, a home equity loan comes with a fixed interest rate and a consistent monthly payment schedule over a set term. This predictability can make it an appealing option for large, one-time expenses.

How much equity can I borrow from my home?

The amount you can borrow depends on your home’s market value, how much you still owe on your mortgage, and your lender’s specific requirements. Most lenders allow you to borrow up to 80% to 85% of your home’s equity.

Here’s how it works:

1. Determine your home’s value: Start with your property’s current market value.

2. Calculate your existing mortgage balance: Subtract the amount you still owe.

3. Apply the loan-to-value ratio (LTV): Multiply your home’s value by your lender’s maximum LTV percentage, then subtract your existing balance to estimate your borrowing potential.

For example, if your home is worth $400,000 and you owe $200,000, you might qualify to borrow up to $140,000 (assuming an 85% LTV).

Home equity loan example

Let’s put the numbers into perspective using an 80% LTV:

• Your home’s appraised value: $350,000
• Outstanding mortgage balance: $150,000
• Maximum LTV ratio: 80%

Using this formula:

$350,000 (home value) x 0.80 (LTV) = $280,000
$280,000 – $150,000 (mortgage balance) = $130,000

In this case, you could borrow up to $130,000 with a home equity loan.