Home equity loan pros and cons: Is it right for you?

Borrowing against your home equity is one of the cheapest ways to get a large sum of cash. It’s also the only type of borrowing where falling behind can cost you your home.

If you need a lump sum for something specific and lasting, like a failing roof, a kitchen renovation or wiping out credit card debt at 20% APR or higher, and you can afford a second payment alongside your mortgage without draining your savings, a home equity loan is worth a serious look. If you need the money for something that won’t outlast the loan, your income is unsteady or you’re planning to sell within a few years, the math works against you.

Pros and cons of a home equity loan

The main requirement for a home equity loan is enough equity in your home. Lenders typically require that you own 15% to 20% outright. Other criteria include good credit and a low amount of debt relative to your income. 

If you check these boxes, home equity loans have several pluses:

Are home equity loans a good idea?

Whether a home equity loan is right for you depends on five things, and each one has a clear answer. 

• How are you using the money? If the expense is a one-time cost that adds lasting value or replaces higher-rate debt, like a structural repair, a kitchen remodel or paying off high-interest credit card balances, a home equity loan is a reasonable fit. If you plan to use the money to pay for a vacation, a wedding, a car or everyday bills, think twice. You’d still be paying for it years after it’s gone, with your house as collateral.
• Can you afford the payment? If you can cover the new payment alongside your mortgage, property taxes and insurance and still keep three to six months of expenses in savings, you have the cushion this loan requires. If the payment only works if you get a raise, bonus or side income that hasn’t arrived yet, push pause. Missing a home equity loan payment isn’t like missing a credit card payment. Remember, your house is collateral.
• How much equity would you have left? If you’d still own 20% or more of your home’s value after borrowing, you have room to absorb a price decline or sell if you need to. If you’d drop below 15%, a modest dip in local values can leave you owing more than the house is worth, with no way to sell without writing a check at closing.
• Will the money still be working for you when you sell? If you’re putting the money into something that raises the home’s sale price, like a kitchen or bath refresh before you list, a short timeline isn’t a problem. If the money is going toward something that won’t show up in the sale price, like tuition, medical bills or consolidating debt, and you expect to sell within a couple of years, price out a personal loan or a 0% introductory APR card first. Paying 2% to 5% in closing costs to borrow for 18 months is a steep premium.
• What’s your current mortgage rate? If your existing mortgage rate is well below what lenders are offering now, a home equity loan lets you tap equity without giving up that low rate. If your current rate is at or above today’s rates, compare a cash-out refinance first. Replacing one loan can cost less than carrying two.

What does a $50,000 home equity loan really cost?

Let’s say you want to borrow $50,000 with a home equity loan at an 8.50% rate. Here’s how much that loan would cost across various repayment terms. Remember: The longer you take to repay the loan, the lower your monthly payment will be, but the more interest you’ll pay over time.

Taking the longest, 30-year term may save $236 a month over the 10-year repayment option, but it’ll cost you an additional $64,000 in interest. That’s more than the loan itself. The general rule of thumb with selecting a loan term is to choose the shortest term you can reasonably afford. Use Bankrate’s mortgage calculator to run the numbers on your loan offers.

When a home equity loan is the wrong choice 

A home equity loan may not be the best financial move for many reasons, starting with how it’s structured. The more equity you convert into debt, the less cushion you have if home values take a dive or you need to sell. If home values in your area are declining, you could end up with negative equity, meaning you owe more than your house is worth. 

An unstable job and shaky finances are also a red flag. If your income dips and you fall behind, you could lose your home to foreclosure. Another mistake is using a home equity loan to cover everyday expenses or non-essential purchases. Shopping, weddings and depreciating assets like cars are all bad moves.

“I’d say the most important thing to consider is how you’ll use the proceeds,” says Jeff Ostrowski, Bankrate writer and housing market analyst. “If you plan to renovate your kitchen or spruce up your bathroom, that’s a smart move. But if you need funds for a vacation, I’d rethink.”

Do all home equity loans have fees?

Yes. Nearly all home equity loans carry fees, though which ones and how much you’ll pay vary by lender. Together, they typically come to 2% to 5% of the amount you borrow, or $1,000 to $2,500 on a $50,000 loan. Some lenders waive certain costs entirely, so ask every lender what they’re willing to drop.

Here’s what you’re likely to see on the itemized list:

• Origination fee: This is what the lender charges you to originate, process and underwrite your loan. The amount varies by lender and the amount you’re borrowing, typically 0.5% to 1% of the loan amount.
• Appraisal fee: An appraisal determines your home’s market value, which then establishes your equity and borrowing power. The cost ranges from $300 to $500, though you may pay more if the house is larger or unique. Many lenders now use an automated valuation model instead of sending an appraiser out, which can cut this fee altogether.
• Credit report fee: The cost to pull your credit report starts at $30 but can be up to $100, if not more. If you’re borrowing with more than one person, that fee could double.
• Document preparation/attorney fees: These fees cover the cost of preparing, processing, and finalizing your home equity loan. Fees can range from $100 to $500.
• Title fees: Since the home serves as collateral for a home equity loan, lenders conduct a title search to determine if there are any existing liens or claims on the property. This fee can range from $75 to $250, depending on location; some can be higher.

Home equity loans vs. HELOCs: What’s the difference?

Both home equity loans and HELOCs (short for home equity line of credit) let you borrow against your home equity, with your property serving as collateral for the debt. But they work differently.

A home equity loan is a type of second mortgage that lets you turn some of the equity in your home into cash. You receive it in a lump sum and repay it at a fixed interest rate through monthly payments, commonly over 5 to 30 years. Your monthly repayment amount will remain the same for the life of your loan.

In contrast, HELOCs are revolving lines of credit — like credit cards — letting you withdraw money as you need it during an initial 5- to 10-year draw period. After that, you’ll enter the repayment period, which generally lasts between 10 and 20 years. During this time, you’ll have to pay back the amount you borrowed, plus interest. HELOC interest rates are typically variable, fluctuating with market rates each month.

The right option depends on your borrowing needs. If you know how much you need and when, take the lump sum and the fixed rate. If the total is uncertain or the spending will play out over years, a HELOC lets you borrow only what you use.

Alternatives to home equity loans

A home equity loan isn’t the only way to borrow, and it isn’t always the cheapest. Compare these before you decide.

• Cash-out refinance: This replaces your existing mortgage with a new loan for a larger amount. You receive the difference (based on your home equity) in ready money. The main upside: You’ll have one monthly payment instead of two. But you’ll get a new mortgage rate on your whole balance and reset repayment on your home, so this option only makes sense if today’s rates are at or below what you’re paying now.
  
  “Many homeowners locked in low mortgage rates that they don’t want to disturb, so a cash-out refinance doesn’t make sense, but a home equity loan can let you tap a small amount of equity while keeping your cheap mortgage intact,” says Ostrowski.
• Personal loan: This borrowing option doesn’t require collateral and can be obtained more quickly, typically in days instead of weeks. However, you typically can’t borrow as much, and you’ll have to repay it sooner. And you’ll almost certainly pay a higher interest rate compared to a home equity loan.
• 0% introductory APR credit card: If you need a smaller amount and can repay the full balance by the end of the promotional period, this option could cost nothing. But if you still have a balance when the intro period ends, your rate jumps and repayment can be pricey, so only use this option if the payoff date is realistic.

Next steps

Shopping around is one of the most important parts of choosing a home equity loan. 

Start with getting quotes from at least three home equity lenders, using a mix of mortgage companies, national banks, regional credit unions, and online lenders. You can start with your current lender, but rates, fees, borrowing limits and loan terms vary across lenders, which is why it makes sense to shop around.  Shop inside a short window. Multiple home equity inquiries filed within roughly two weeks generally count as a single inquiry for credit scoring purposes, so comparing lenders doesn’t cost you points. 

When comparing offers, look at the total cost of the loan and the monthly payments, not just the interest rates. Check out online reviews of customer service and borrower experience, such as Bankrate’s home equity lender reviews.

Once you’ve chosen a lender, the application process is similar to applying for a mortgage: You’ll have to submit your financials and employment information. The lender will appraise your home to determine its value and, based on that, how much equity you have to borrow against. After approval, you can move forward with accessing your home equity.

Frequently asked questions

• How do the pros and cons of a home equity loan compare to HELOCs?

  A home equity loan trades flexibility for certainty, and a HELOC does the opposite. With a home equity loan, you get the full amount upfront at a fixed rate, so your payment is the same every month, and you know the total cost on day one. That suits a defined expense with a known price. A HELOC gives you a revolving line you draw from as you go, and you pay interest only on what you use, which suits costs that are spread out or hard to pin down. The catch is that HELOC rates are usually variable, so your payment can rise.

• Can you get a home equity loan without a mortgage?

  Yes. You can take equity out of your home even if you own it free and clear. In fact, it may be easier to get a home equity loan if you’re mortgage-free because your residence has no other debts attached to it, so you can access a much larger portion of your equity. Plus, without a monthly mortgage payment, you likely have a low debt-to-income ratio, which could qualify you for a better interest rate.

   

• When should you use a home equity loan instead of refinancing your mortgage?

  Use a home equity loan when your current mortgage rate is better than what lenders offer today. A cash-out refinance pays off your existing mortgage and replaces it, so you get a new rate and term on the entire balance. If you give up a low rate to access your equity, the savings can vanish. A home equity loan leaves your first mortgage alone and adds a second payment instead. Refinancing is the better move if today’s rates are lower than your current rate and you’ll stay in the home long enough to recoup the closing costs.