A home equity loan is also a loan that allows you to borrow against your equity. But it’s not exactly the same as a cash-out refinance.
With a home equity loan, you’re not replacing your current mortgage. Instead, you’re taking out a new second mortgage that’s based on the amount of equity you’re borrowing against. Lenders may allow you to borrow up to 90% of your home’s value for a home equity loan.
So going back to the previous example of a home valued at $350,000, you’d be able to borrow up to $315,000. If you owe $250,000 on the mortgage, you could borrow $65,000 in equity, which is quite a bit more than what you could get with a cash-out refinance loan.
You still get a lump sum of money at closing that you can use to pay for home repairs or improvements, consolidate debt, or cover other expenses. But the interest rate on your first mortgage doesn’t change. And you’ll now have two mortgage payments to make each month going forward, versus one.
Home equity loans are often grouped together with home equity lines of credit or HELOCs. But they’re not identical either. With a home equity loan, you receive a lump sum of money. A HELOC is a line of credit you can draw against as needed.
Home equity loans tend to have fixed interest rates while home equity lines of credit may have variable interest rates. This means your interest rate can go up or down over time, which can affect your monthly payments.
Home equity loan pros
- Fixed interest rates can offer predictability, since payments stay the same over the life of the loan.
- Potentially borrow more of your home equity than you could with a cash-out refinance loan.
- Interest may be tax-deductible when the money is used for home improvements.
Home equity loan cons
- May have higher interest rates than home equity lines of credit.
- Failing to pay a home equity loan could lead to a foreclosure proceeding since the home is used as collateral.
- Two mortgage payments to make each month could put a strain on your budget.